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Table Of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2016

 

Commission File Number: 001-34226

 

1st Century Bancshares, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 

26-1169687

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

1875 Century Park East, Suite 1400

Los Angeles, California 90067

(Address of principal executive offices)

(Zip Code)

 

(310) 270-9500

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.        Yes ☒  No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ☒  No  ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Large accelerated filer ☐

Accelerated filer ☐

   

Non-accelerated filer ☐

Smaller reporting company ☒

(Do not check if a smaller reporting company)

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ☐  No  ☒

 

10,336,884 shares of common stock of the registrant were outstanding as of April 29, 2016.

 



 

 

 

1st Century Bancshares, Inc.

Quarterly Report on Form 10-Q

March 31, 2016

 

Table of Contents

 

   

Page

PART I. FINANCIAL INFORMATION

 
     

Item 1.

Financial Statements

 
     
 

Consolidated Balance Sheets — March 31, 2016 (unaudited) and December 31, 2015

4

     
 

Unaudited Consolidated Statements of Operations and Comprehensive Income — Three months ended March 31, 2016 and 2015

5

     
 

Unaudited Consolidated Statements of Changes in Stockholders’ Equity — Three months ended March 31, 2016 and 2015

6

     
 

Unaudited Consolidated Statements of Cash Flows — Three months ended March 31, 2016 and 2015

7

     
 

Notes to Unaudited Consolidated Financial Statements

8

     

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

29

     

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

41

     

Item 4.

Controls and Procedures

41

     

PART II. OTHER INFORMATION

 
     

Item 1.

Legal Proceedings

42

     

Item 1A.

Risk Factors

42

     

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

44

     

Item 3.

Defaults Upon Senior Securities

44

     

Item 4.

Mine Safety Disclosures

44

     

Item 5.

Other Information

44

     

Item 6.

Exhibits

45

     

Signatures

 

46

 

  

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

 

This Quarterly Report on Form 10-Q may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. You can find many (but not all) of these statements by looking for words such as “approximates,” “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “would,” “may” and other similar expressions in this Quarterly Report on Form 10-Q. With respect to any such forward-looking statements, the Company claims the protection of the safe harbor provided for in the Private Securities Litigation Reform Act of 1995, as amended. The Company cautions investors that any forward-looking statements presented in this Quarterly Report on Form 10-Q, or those that the Company may make orally or in writing from time to time, are based on the beliefs of, assumptions made by, and information available to, management at the time such statements are first made. Actual outcomes will be affected by known and unknown risks, trends, uncertainties and factors that are beyond the Company’s control or ability to predict.  Although the Company believes that management’s beliefs and assumptions are reasonable, they are not guarantees of future performance and some will inevitably prove to be incorrect. As a result, the Company’s actual future results can be expected to differ from management’s expectations, and those differences may be material and adverse to the Company’s business, results of operations and financial condition. Accordingly, investors should use caution in placing any reliance on forward-looking statements to anticipate future results or trends.

 

Some of the risks and uncertainties that may cause the Company’s actual results, performance or achievements to differ materially from those expressed include, but are not limited to, the following: the risk that 1st Century stockholders do not approve the merger; the occurrence of any event, change or other circumstances that could give rise to the termination of the merger agreement; the response by stockholders to the merger; the failure to satisfy each of the conditions to the consummation of the merger, including but not limited to, the risk that a governmental entity may prohibit, delay or refuse to grant approval for the consummation of the merger on acceptable terms, or at all; risks related to disruption of management’s attention from 1st Century’s ongoing business operations due to the merger; the effect of the announcement of the merger on 1st Century’s relationships with its customers, suppliers, operating results and business generally; the risk that any announcements relating to the merger could have adverse effects on the market price of 1st Century’s common stock; the outcome of any legal proceedings related to the merger; risks related to employee retention as a result of the merger; the risk that the merger will not be consummated within the expected time period or at all; the impact of changes in interest rates; political instability; changes in the monetary policies of the U.S. Government; a renewed decline in economic conditions or continued sluggish growth; deterioration in the value of California real estate, both residential and commercial; an increase in the level of non-performing assets and charge-offs; further increased competition among financial institutions; the Company’s ability to continue to attract interest bearing deposits and quality loan customers; further government regulation, including regulations regarding capital requirements, and the implementation and costs associated with the same; internal and external fraud and cyber-security threats including the loss of bank or customer funds, loss of system functionality or the theft or loss of data; management’s ability to successfully manage the Company’s operations; and the other risks set forth in the Company’s reports filed with the U.S. Securities and Exchange Commission. For further discussion of these and other factors, see “Item 1A. Risk Factors” in this Quarterly Report on Form 10-Q and the Company’s 2015 Annual Report on Form 10-K.

 

Any forward-looking statements in this Quarterly Report on Form 10-Q and all subsequent written and oral forward-looking statements attributable to the Company or any person acting on behalf of the Company are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. The Company does not undertake any obligation to release publicly any revisions to forward-looking statements to reflect events or circumstances after the date such forward looking statements are made, and hereby specifically disclaims any intention to do so, unless required by law.

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. — Financial Statements

 

1st Century Bancshares, Inc.

Consolidated Balance Sheets

(in thousands, except share and per share data)

 

   

March 31, 2016

(unaudited)

   

December 31, 2015

 

ASSETS

               

Cash and due from banks

  $ 11,071     $ 8,889  

Interest earning deposits at other financial institutions

    41,313       45,676  

Total cash and cash equivalents

    52,384       54,565  

Investment securities — Available for Sale (“AFS”), at estimated fair value

    72,464       74,010  

Loans, net of allowance for loan losses of $9,161 and $8,961 at March 31, 2016 and December 31, 2015, respectively

    600,021       589,472  

Premises and equipment, net

    1,690       1,627  

Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) stock

    5,022       4,915  

Accrued interest and other assets

    7,896       7,361  

Total Assets

  $ 739,477     $ 731,950  
                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

               

Non-interest bearing demand deposits

  $ 383,486     $ 362,451  

Interest bearing deposits:

               

Interest bearing checking (“NOW”)

    36,385       32,406  

Money market deposits and savings

    187,381       155,572  

Certificates of deposit less than $250

    1,199       1,243  

Certificates of deposit of $250 or greater

    46,506       46,505  

Total deposits

    654,957       598,177  

Other borrowings

    15,000       65,000  

Accrued interest and other liabilities

    3,568       3,870  

Total Liabilities

    673,525       667,047  
                 

Commitments and contingencies (Note 9)

               
                 

Stockholders’ Equity:

               

Preferred stock, $0.01 par value — 10,000,000 shares authorized, none issued and outstanding at March 31, 2016 and December 31, 2015, respectively

           

Common stock, $0.01 par value — 50,000,000 shares authorized, 12,673,633 and 12,655,633 issued at March 31, 2016 and December 31, 2015, respectively

    127       127  

Additional paid-in capital

    75,668       75,396  

Retained earnings

    1,151       878  

Accumulated other comprehensive income

    515       11  

Treasury stock at cost — 2,336,749 shares at both March 31, 2016 and December 31, 2015

    (11,509

)

    (11,509

)

Total Stockholders’ Equity

    65,952       64,903  

Total Liabilities and Stockholders’ Equity

  $ 739,477     $ 731,950  

 

The accompanying notes are an integral part of the unaudited consolidated financial statements.

 

  

1st Century Bancshares, Inc.

Unaudited Consolidated Statements of Operations and Comprehensive Income

(in thousands, except per share data)

 

   

Three Months Ended March 31,

 
   

2016

   

2015

 

Interest and fee income on:

               

Loans

  $ 6,534     $ 4,717  

Investments

    331       347  

Other

    113       114  

Total interest and fee income

    6,978       5,178  
                 

Interest expense on:

               

Deposits

    139       110  

Borrowings

    57       48  

Total interest expense

    196       158  

Net interest income

    6,782       5,020  
                 

Provision for loan losses

    200       150  

Net interest income after provision for loan losses

    6,582       4,870  
                 

Non-interest income:

               

Gain on sale of AFS investment securities

          75  

Other operating income

    198       155  

Total non-interest income

    198       230  

Non-interest expenses:

               

Compensation and benefits

    3,038       2,695  

Occupancy

    460       475  

Professional fees

    340       178  

Technology

    299       230  

Marketing

    126       101  

FDIC assessments

    111       95  

Merger related expenses

    861        

Form S-1 related expenses

    268        

Other operating expenses

    795       765  

Total non-interest expenses

    6,298       4,539  

Income before income taxes

    482       561  

Income tax provision

    209       246  

Net income

    273       315  
                 

Other Comprehensive Income:

               

Net change in unrealized gains on AFS investments, net of tax

    504       317  

Comprehensive Income

  $ 777     $ 632  
                 

Basic earnings per share

  $ 0.03     $ 0.03  

Diluted earnings per share

  $ 0.03     $ 0.03  

 

The accompanying notes are an integral part of the unaudited consolidated financial statements.

 

 

1st Century Bancshares, Inc.

Unaudited Consolidated Statements of Changes in Stockholders’ Equity

(in thousands, except share data)

 

   

Common Stock

           

Retained Earnings

   

Accumulated Other

   

Treasury Stock

   

Total

 
   

Issued

           

Additional

   

(Accumulated

   

Comprehensive

   

Number of

           

Stockholders’

 
   

Shares

   

Amount

   

Paid-in Capital

   

Deficit)

   

Income

   

Shares

   

Amount

   

Equity

 

Balance at December 31, 2014

    12,129,310     $ 121     $ 71,736     $ (1,675

)

  $ 162       (1,988,869

)

  $ (8,651

)

  $ 61,693  

Restricted stock issued

    26,000       1       (1

)

                             

Compensation expense associated with restricted stock awards, net of estimated forfeitures

                224                               224  

Net income

                      315                         315  

Other comprehensive income

                            317                   317  

Balance at March 31, 2015

    12,155,310     $ 122     $ 71,959     $ (1,360

)

  $ 479       (1,988,869

)

  $ (8,651

)

  $ 62,549  
                                                                 

Balance at December 31, 2015

    12,655,633     $ 127     $ 75,396     $ 878     $ 11       (2,336,749

)

  $ (11,509

)

  $ 64,903  

Restricted stock issued

    18,000                                            

Compensation expense associated with restricted stock awards, net of estimated forfeitures

                272                               272  

Net income

                      273                         273  

Other comprehensive income

                            504                   504  

Balance at March 31, 2016

    12,673,633     $ 127     $ 75,668     $ 1,151     $ 515       (2,336,749

)

  $ (11,509

)

  $ 65,952  

 

The accompanying notes are an integral part of the unaudited consolidated financial statements.

 

 

1st Century Bancshares, Inc.

Unaudited Consolidated Statements of Cash Flows

(in thousands)

 

   

Three Months Ended March 31,

 
   

2016

   

2015

 

Cash flows from operating activities:

               

Net income

  $ 273     $ 315  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Depreciation and amortization of premises and equipment

    132       152  

Amortization of premiums on investment securities, net

    120       156  

Provision for loan losses

    200       150  

Amortization of deferred loan fees and costs, net

    17       6  

Gain on sale of AFS investment securities

          (75

)

Non-cash stock compensation, net of forfeitures

    272       224  

(Increase) decrease in accrued interest and other assets

    (888

)

    291  

Decrease in accrued interest and other liabilities

    (302

)

    (548

)

Net cash (used in) provided by operating activities

    (176

)

    671  

Cash flows from investing activities:

               

Activities in AFS investment securities:

               

Purchases

          (2,010

)

Maturities and principal reductions

    2,283       3,195  

Proceeds from sale of securities

          5,983  

Increase in loans, net

    (10,766

)

    (36,992

)

Purchase of premises and equipment

    (195

)

    (332

)

Purchase of FRB stock

    (107

)

     

Net cash used in investing activities

    (8,785

)

    (30,156

)

Cash flows from financing activities:

               

Net increase in deposits

    56,780       31,124  

Repayment of other short-term borrowings

    (50,000

)

     

Net cash provided by financing activities

    6,780       31,124  

(Decrease) increase in cash and cash equivalents

    (2,181

)

    1,639  

Cash and cash equivalents, beginning of period

    54,565       58,464  

Cash and cash equivalents, end of period

  $ 52,384     $ 60,103  
                 

Supplemental cash flow information:

               

Cash paid during the period for:

               

Interest

  $ 183     $ 170  

Income taxes

  $ 1,700     $ 140  

 

The accompanying notes are an integral part of the unaudited consolidated financial statements.

 

 

1st Century Bancshares, Inc.

Notes to Unaudited Consolidated Financial Statements

 

(1)

Summary of Significant Accounting Policies

 

Nature of Operations

 

1st Century Bancshares, Inc., a Delaware corporation (“Bancshares”) is a bank holding company with one subsidiary, 1st Century Bank, National Association (the “Bank”). The Bank commenced operations on March 1, 2004 in the State of California operating under the laws of a national association regulated by the Office of the Comptroller of the Currency (the “OCC”). The Bank is a commercial bank that focuses on closely held and family owned businesses and their employees, professional service firms, real estate professionals and investors, the legal, accounting and medical professions, and small and medium-sized businesses and individuals principally in Los Angeles County. The Bank provides a wide range of banking services to meet the financial needs of the local residential community, with an orientation primarily directed toward owners and employees of the Bank’s business client base. The Bank is subject to both the regulations of and periodic examinations by the OCC, which is the Bank’s federal regulatory agency. Bancshares and the Bank are collectively referred to herein as “the Company.”

 

Proposed Merger with Midland Financial Co.

 

On March 10, 2016, Bancshares entered into an Agreement and Plan of Merger (the “Merger Agreement”), with Midland Financial Co., an Oklahoma corporation (“Midland”), and MC 2016 Corp., a Delaware corporation and wholly-owned subsidiary of Midland (“Merger Sub”), pursuant to which, upon the terms and subject to the conditions set forth therein, Merger Sub will merge (the “Merger”) with and into Bancshares, with Bancshares surviving the Merger as a wholly-owned subsidiary of Midland. Simultaneously with the Merger, the Bank will merge (the “Bank Merger”) with and into MidFirst Bank, a federally-chartered savings association and a wholly-owned subsidiary of Midland (“MidFirst”), with MidFirst surviving the Bank Merger. Immediately after the Merger and Bank Merger described above, Bancshares, as the surviving corporation in the Merger, will merge with and into Midland, with Midland as the surviving corporation.

 

Subject to the terms and conditions set forth in the Merger Agreement, upon consummation of the Merger, each outstanding share of Bancshares common stock, par value $0.01 per share, excluding shares owned by Midland, Bancshares or either of their subsidiaries (subject to certain exceptions) or shares owned by stockholders who have validly made and not effectively withdrawn a demand for appraisal rights, will be converted into the right to receive $11.22 in cash.

 

Completion of the Merger is subject to certain closing conditions, including approval by Bancshares’ stockholders and the receipt of certain required regulatory approvals. Midland and Bancshares currently expect that the Merger will be completed during the second half of 2016 or sooner. However, it is possible that factors outside the control of both companies, including whether or when the required regulatory approvals will be received, could result in the Merger being completed at a different time or not at all. The Company recorded $861,000 in merger-related expenses during the three months ended March 31, 2016.

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all footnotes as would be necessary for a fair presentation of financial position, results of operations and comprehensive income, changes in stockholders’ equity and cash flows in conformity with accounting principles generally accepted in the United States of America (“GAAP”). However, these interim unaudited consolidated financial statements reflect all adjustments (consisting solely of normal recurring adjustments and accruals) which, in the opinion of management, are necessary for a fair presentation of financial position, results of operations and comprehensive income, changes in stockholders’ equity and cash flows for the interim period presented. These unaudited consolidated financial statements have been prepared on a basis consistent with, and should be read in conjunction with, the audited consolidated financial statements as of and for the year ended December 31, 2015, and the notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 filed with the SEC, under the Securities and Exchange Act of 1934, (the “Exchange Act”). The unaudited consolidated financial statements include the accounts of Bancshares and the Bank. All intercompany accounts and transactions have been eliminated.

 

The results of operations for the three months ended March 31, 2016 are not necessarily indicative of the results of operations that may be expected for any other interim period or for the year ending December 31, 2016.

 

  

The Company’s accounting and reporting policies conform to GAAP and to general practices within the banking industry. A summary of the significant accounting and reporting policies consistently applied in the preparation of the accompanying unaudited consolidated financial statements follows:

 

Use of Estimates

 

Management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Certain assumptions and estimates could prove to be incorrect and cause actual results to differ materially and adversely from the amounts reported in the consolidated financial statements included herewith.

 

Cash and Cash Equivalents

 

Cash and cash equivalents include cash and due from banks, interest earning deposits at other financial institutions with original maturities less than 90 days and all highly liquid investments with original maturities of less than 90 days.

 

Cash Flows

 

Cash and cash equivalents include cash, deposits with other financial institutions with maturities fewer than 90 days, and federal funds sold. Net cash flows are reported for loan and deposit transactions, interest bearing deposits in other financial institutions and short-term borrowings.

 

Investment Securities

 

Investment securities are classified in three categories. Debt securities that management has a positive intent and ability to hold to maturity are classified as “Held to Maturity” or “HTM” and are recorded at amortized cost. Debt and equity securities bought and held principally for the purpose of selling in the near term are classified as “Trading” securities and are measured at fair value, with unrealized gains and losses included in earnings. Debt and equity securities not classified as “Held to Maturity” or “Trading” with readily determinable fair values are classified as “Available for Sale” or “AFS” and are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. The Company uses estimates from third parties in arriving at fair value determinations which are derived in accordance with fair value measurement standards.

 

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of investment securities below their cost that are deemed to be other-than-temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income provided that management does not have the intent to sell the securities and it is more likely than not that management will not have to sell the security before recovery of its cost basis. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

 

Federal Reserve Bank Stock and Federal Home Loan Bank Stock

 

The Bank is a member of the Federal Reserve System (“FRB”). FRB stock is carried at cost and is considered a nonmarketable equity security. Cash dividends from the FRB are reported as interest income on an accrual basis.

 

The Bank is a member and stockholder of the capital stock of the Federal Home Loan Bank of San Francisco (“FHLB of San Francisco” or “FHLB”). Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB of San Francisco stock is carried at cost and is considered a nonmarketable equity security. Both cash and stock dividends are reported as interest income.

 

Loans

 

Loans, net, are stated at the unpaid principal balances less the allowance for loan losses and unamortized deferred fees and costs. Loan origination fees, net of related direct costs, are deferred and accreted to interest income as an adjustment to yield over the respective maturities of the loans using the effective interest method.

 

Interest on loans is accrued as earned on a daily basis, except where reasonable doubt exists as to the collection of interest and principal, in which case the accrual of interest is discontinued and the loan is placed on non-accrual status. Loans are placed on non-accrual at the time principal or interest is 90 days delinquent unless well secured and in the process of collection. Interest on non-accrual loans is accounted for on a cash-basis or cost-recovery method, until qualifying for return to accrual status. In order for a loan to return to accrual status, all principal and interest amounts owed must be brought current and future payments must be reasonably assured.

 

 

A loan is charged-off at any time the loan is determined to be uncollectible. Collateral dependent loans, which generally include commercial real estate loans, residential loans, and construction and land loans, are typically charged down to their net realizable value when a loan is impaired or on non-accrual status. All other loans are typically charged-off when, based upon current available facts and circumstances, it’s determined that either: (1) a loan is uncollectible, (2) repayment is determined to be protracted beyond a reasonable time frame, or (3) the loan is classified as a loss determined by either the Bank’s internal review process or by external examiners.

 

Loans are considered impaired when, based upon current information and events, it is probable that the Company will be unable to collect all principal and interest amounts due according to the original contractual terms of the loan agreement on a timely basis. The Company evaluates impairment on a loan-by-loan basis. Once a loan is determined to be impaired, the impairment is measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate or by using the loan’s most recent market value or the fair value of the collateral if the loan is collateral dependent. Loans that experience insignificant payment delays or payment shortfalls are generally not considered to be impaired.

 

When the measurement of an impaired loan is less than the recorded amount of the loan, a valuation allowance is established by recording a charge to the provision for loan losses. Subsequent increases or decreases in the valuation allowance for impaired loans are recorded by adjusting the existing valuation allowance for the impaired loan with a corresponding charge or credit to the provision for loan losses. The Company’s policy for recognizing interest income on impaired loans is the same as that for non-accrual loans.

 

Troubled Debt Restructurings

 

In situations where, for economic or legal reasons related to a borrower’s financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a troubled debt restructuring (“TDR”). Management strives to identify borrowers in financial difficulty early and work with them to modify their loans to more affordable terms before their loan reaches nonaccrual status. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses.

 

Allowance for Loan Losses

 

The allowance for loan losses is established through a provision for loan losses charged to operations and represents an estimate of probable credit losses inherent in the Company’s loan portfolio that have been incurred as of the balance sheet date. Loan losses are charged against the allowance when management believes that principal is uncollectible. Subsequent repayments or recoveries, if any, are credited to the allowance. Management periodically assesses the adequacy of the allowance for loan losses by reference to many quantitative and qualitative factors that may be weighted differently at various times depending on prevailing conditions. The provisions reflect management’s evaluation of the adequacy of the allowance based, in part, upon the historical loss experience of the loan portfolio, as well as estimates from historical peer group loan loss data and the loss experience of other financial institutions, augmented by management judgment. During this process, loans are separated into the following portfolio segments: commercial loans, commercial real estate, residential, land and construction, and consumer and other loans. The relative significance of risk considerations vary by portfolio segment. For commercial loans, commercial real estate loans and land and construction, the primary risk consideration is a borrower’s ability to generate sufficient cash flows to repay their loan. Secondary considerations include the creditworthiness of guarantors and the valuation of collateral. In addition to the creditworthiness of a borrower, the type and location of real estate collateral is an important risk factor for commercial real estate and land and construction loans. The primary risk consideration for residential loans and consumer loans are a borrower’s personal cash flow and liquidity, as well as collateral value.

 

Loss ratios for all portfolio segments are evaluated on a quarterly basis. Loss ratios associated with historical loss experience are determined based on a rolling migration analysis of each portfolio segment within the portfolio. This migration analysis estimates loss factors based on the performance of each portfolio segment over a four and a half year time period. These loss ratios are then adjusted, if determined necessary, based on other factors including, but not limited to, historical peer group loan loss data and the loss experience of other financial institutions. Management carefully monitors changing economic conditions, the concentrations of loan categories, values of collateral, the financial condition of the borrowers, the history of the loan portfolio, and historical peer group loan loss data to determine the adequacy of the allowance for loan losses. As a part of this process, management typically focuses on loan-to-value (“LTV”) percentages to assess the adequacy of loss ratios of collateral dependent loans within each portfolio segment discussed above, trends within each portfolio segment, as well as general economic and real estate market conditions where the collateral and borrower are located. For loans that are not collateral dependent, which generally consist of commercial and consumer and other loans, management typically focuses on general business conditions where the borrower operates, trends within the portfolio, and other external factors to evaluate the severity of loss factors. The allowance is based on estimates and actual losses may vary from the estimates.

 

 

In addition, regulatory agencies, as a part of their examination process, periodically review the Bank’s allowance for loan losses, and may require the Bank to make additions to the allowance based on their judgment about information available to them at the time of their examinations. No assurance can be given that adverse future economic conditions will not lead to increased delinquent loans, and increases in the provision for loan losses and/or charge-offs.

 

Other Real Estate Owned

 

Other Real Estate Owned (“OREO”) represents real estate acquired through or in lieu of foreclosure. OREO is held for sale and is initially recorded at fair value less estimated costs of disposition at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of cost or estimated fair value less costs of disposition. OREO is included in accrued interest and other assets within the Consolidated Balance Sheets and the net operating results, if any, from OREO are recognized as non-interest expense within the unaudited Consolidated Statements of Operations and Comprehensive Income.

 

Furniture, Fixtures and Equipment, net

 

Leasehold improvements and furniture, fixtures and equipment are carried at cost, less depreciation and amortization. Furniture, fixtures and equipment are depreciated using the straight-line method over the estimated useful life of the asset (three to ten years). Leasehold improvements are depreciated using the straight-line method over the terms of the related leases or the estimated lives of the improvements, whichever is shorter.

 

Advertising Costs

 

Advertising costs are expensed as incurred.

 

Income Taxes

 

The Company files consolidated federal and combined state income tax returns. Income tax expense or benefit is the total of the current year income tax payable or refundable and the change in the deferred tax assets and liabilities (excluding deferred tax assets and liabilities related to components of other comprehensive income). Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax basis of assets and liabilities, computed using enacted tax rates.

 

Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in the rates and laws. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. The Company records a valuation allowance if it believes, based on all available evidence, that it is “more likely than not” that the future tax assets will not be realized. This assessment requires management to evaluate the Company’s ability to generate sufficient future taxable income or use eligible tax carrybacks, if any, to determine the need for a valuation allowance.

 

At March 31, 2016 and December 31, 2015, the Company did not have any tax benefits disallowed under accounting standards for uncertainties in income taxes. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. If applicable, the Company has elected to record interest accrued and penalties related to unrecognized tax benefits in tax expense.

 

Comprehensive Income

 

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. However, certain changes in assets and liabilities, such as unrealized gains and losses on Available for Sale securities, are reported as a separate component of the stockholders’ equity section of the Consolidated Balance Sheets and, along with net income, are components of comprehensive income.

 

 

Earnings per Share

 

The Company reports both basic and diluted earnings per share. Basic earnings per share is determined by dividing net income by the average number of shares of common stock outstanding, while diluted earnings per share is determined by dividing net income by the average number of shares of common stock outstanding adjusted for the dilutive effect of common stock equivalents. Potential dilutive common shares related to outstanding stock options and restricted stock are determined using the treasury stock method. For the three months ended March 31, 2016 and 2015, there were none and 350,073, respectively, of weighted average stock options that were excluded from the diluted earnings per share calculation due to their antidilutive impact. For the three months ended March 31, 2016 and 2015, there were 11,868 and 17,044, respectively, of weighted average restricted shares that were excluded from the diluted earnings per share calculation due to their antidilutive impact.

 

   

Three Months Ended March 31,

 

(dollars in thousands)

 

2016

   

2015

 

Net income

  $ 273     $ 315  

Average number of common shares outstanding

    9,662,321       9,537,677  

Effect of dilution of restricted stock

    300,539       266,656  

Average number of common shares outstanding used to calculate diluted earnings per common share

    9,962,860       9,804,333  

 

Fair Value of Financial Instruments

 

The Company is required to make certain disclosures about its use of fair value measurements in the preparation of its financial statements. These standards establish a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect management’s estimates about market data.

 

Level 1

 

Valuation is based upon quoted prices for identical instruments traded in active markets.  Level 1 instruments include securities traded on active exchange markets, such as the New York Stock Exchange, as well as U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets.

     

Level 2

 

Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.  Level 2 instruments include securities traded in less active dealer or broker markets.

 

Level 3

 

Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market.  These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability.  Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

 

Stock-Based Compensation

 

The Company has granted restricted stock awards to directors, employees, and a vendor under the Company’s 2005 Amended and Restated Equity Incentive Plan (the “Equity Incentive Plan”) and the 2013 Equity Incentive Plan. The restricted stock awards are considered fixed awards as the number of shares and fair value is known at the date of grant and the fair value at the grant date is amortized over the vesting and/or service period.

 

Recent Accounting Pronouncements

 

In August 2014, the Financial Accounting Standard Board (FASB) issued Accounting Standard Update (ASU) No. 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40) (ASU 2014-15). The objective of ASU 2014-15 is to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and provide related disclosures. Currently, GAAP does not provide guidance to evaluate whether there is substantial doubt regarding an organization’s ability to continue as a going concern. This ASU provides guidance to an organization’s management, with principles and definitions to reduce diversity in the timing and content of financial statement disclosures commonly provided by organizations. ASU 2014-15 is effective for periods ending after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016.

 

 

In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606) (ASU 2015-14). On May 28, 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), with an original effective date for annual reporting periods beginning after December 15, 2016. The core principal of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2015-14 deferred the effective date of ASU 2014-09 to annual periods and interim periods within those annual periods beginning after December 15, 2017. The Company is currently evaluating the effects of ASU 2015-14 on its financial statements and disclosures, if any.

 

Effective January 2016, the Company prospectively adopted ASU 2015-05, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting or Fees Paid in a Cloud Computing Arrangement (ASU 2015-05). ASU 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. As a result, all software licenses within the scope of this guidance will be accounted for consistently with other licenses of intangible assets. The adoption of ASU 2015-05 did not have a material effect on the Company’s financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (ASU 2016-02). ASU 2016-02 is intended to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing key information about leasing arrangements. For public business entities, this ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2018. The Company is currently evaluating the effects of ASU 2016-02 on its financial statements and disclosures.

 

In March 2016, the FASB issued ASU 2016-05, Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships (ASU 2016-05). ASU 2016-05 clarifies that a change in the counterparty to a derivative instrument (a novation) that has been designated as the hedging instrument does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. Public business entities have the option to apply this ASU on a prospective basis or a modified retrospective basis. It is effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. The Company intends to apply this guidance prospectively and does not expect it to have a material impact on its financial statements or disclosures.

 

In March 2016, the FASB issued ASU 2016-06, Contingent Put and Call Options in Debt Instruments (ASU 2016-06). ASU 2016-06 clarifies the steps required to determine if an embedded derivative should be bifurcated from a host contract in order to resolve diversity in practice. For public business entities, this ASU will be applied on a modified retrospective basis for annual periods and interim periods within those annual periods beginning after December 15, 2016. The Company is currently evaluating the effects of ASU 2016-06 on its financial statements and disclosures.

 

In March 2016, the FASB issued ASU 2016-07, Simplifying the Transition to the Equity Method of Accounting (ASU 2016-07). ASU 2016-07 was issued as part of the FASB’s initiative to identify, evaluate and improve areas of generally accepted accounting principles for which cost and complexity can be reduced while maintaining the usefulness of the information in the financial statements. ASU 2016-07 eliminates the requirement to retroactively adopt the equity method of accounting when an investment qualifies for the use of the equity method as a result of an increase in the level of ownership or degree of influence. For public business entities, this ASU will be applied on a prospective basis for annual periods and interim periods within those annual periods beginning after December 15, 2016. The Company does not expect the adoption of ASU 2016-06 to have a material impact on its financial statements or disclosures

 

In March 2016, the FASB issued ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net) (ASU 2016-08). ASU 2016-08 clarifies the implementation guidance in ASU 2014-09, Revenue from Contracts with Customers, on principal versus agent considerations and whether an entity reports revenue on a gross or net basis. For public business entities, this ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. The Company is currently evaluating the effects of ASU 2014-09 and ASU 2016-08 on its financial statements and disclosures.

 

 

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). ASU 2016-09 includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. The areas for simplification include income tax consequences, forfeitures, classification of awards as either equity or liabilities and classification on the statement of cash flows. This ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2016 and early adoption is permitted for financial statements that have not been previously issued.

 

(2)

Investments

 

The following is a summary of the investments categorized as Available for Sale at March 31, 2016 and December 31, 2015:

 

           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

   

Fair

 

(in thousands)

 

Cost

   

Gains

   

Losses

   

Value

 

At March 31, 2016:

                               

Investments — Available for Sale

                               

U.S. Treasuries and Government Agencies

  $ 34,410     $ 676     $     $ 35,086  

Residential Mortgage-Backed Securities

    37,179       264       (65

)

    37,378  

Total

  $ 71,589     $ 940     $ (65

)

  $ 72,464  

At December 31, 2015:

                               

Investments — Available for Sale

                               

U.S Treasuries and Government Agencies

  $ 34,417     $ 184     $ (2

)

  $ 34,599  

Residential Mortgage-Backed Securities

    39,575       116       (280

)

    39,411  

Total

  $ 73,992     $ 300     $ (282

)

  $ 74,010  

 

The Company did not have any investment securities categorized as “Held to Maturity” or “Trading” at March 31, 2016 or December 31, 2015. At March 31, 2016 and December 31, 2015, there were no holdings of securities of any one issuer other than the U.S. government or its agencies, in an amount greater than 10% of shareholders’ equity.

 

Additionally, at March 31, 2016 and December 31, 2015, the fair value of securities pledged to the State of California Treasurer’s Office to secure their deposits was $54.7 million and $55.9 million, respectively. Deposits from the State of California were $46.0 million at both March 31, 2016 and December 31, 2015.

 

The following table summarizes the fair value of AFS securities and the weighted average yield of investment securities by contractual maturity at March 31, 2016. Residential mortgage-backed securities are included in maturity categories based on their stated maturity date. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. The weighted average life of these securities was 3.26 years at March 31, 2016.

 

(dollars in thousands)

Available for Sale

 

1 Year or Less

   

Weighted Average

Yield

   

After 1 Through 5 Years

   

Weighted Average

Yield

   

After 5 Through 10 Years

   

Weighted Average

Yield

   

After 10 Years

   

Weighted Average

Yield

   

Total

   

Weighted Average

Yield

 

U.S. Treasuries and Government Agencies

  $      

%

  $ 30,689       1.86

%

  $ 4,397       2.08

%

  $      

%

  $ 35,086       1.89

%

Residential Mortgage-Backed Securities

                748       3.40       20,894       1.62       15,736       1.92       37,378       1.78  

Total

  $      

%

  $ 31,437       1.90

%

  $ 25,291       1.70

%

  $ 15,736       1.92

%

  $ 72,464       1.83

%

 

A total of 10 and 31 securities had unrealized losses at March 31, 2016 and December 31, 2015, respectively. Information pertaining to securities with gross unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

 

 

 

 

   

Less than Twelve Months

   

Twelve Months or More

 

(in thousands)

 

Gross

Unrealized

Losses

   

Fair Value

   

Gross

Unrealized

Losses

   

Fair Value

 

At March 31, 2016:

                               

Investments-Available for Sale

                               

Residential Mortgage-Backed Securities

  $ (27

)

  $ 6,488     $ (38

)

  $ 4,018  

At December 31, 2015:

                               

Investments-Available for Sale

                               

U.S Treasuries and Government Agencies

  $ (2

)

  $ 3,995     $     $  

Residential Mortgage-Backed Securities

    (205

)

    23,942       (75

)

    4,221  

 

The Company’s assessment that it has the ability to continue to hold impaired investment securities along with its evaluation of their future performance provide the basis for it to conclude that its impaired securities are not other-than-temporarily impaired. In assessing whether it is more likely than not that the Company will be required to sell any impaired security before its anticipated recovery, which may be at their maturity, it considers the significance of each investment, the amount of impairment, as well as the Company’s liquidity position and the impact on the Company’s capital position. As a result of its analyses, the Company determined at March 31, 2016 and December 31, 2015 that the unrealized losses on its securities portfolio on which impairments had not been recognized are temporary.

 

There were no securities sold during the three months ended March 31, 2016. During the three months ended March 31, 2015, the Company sold available for sale investment securities with an amortized cost of $5.9 million resulting in realized gains of $75,000.

 

(3)

Loans, Allowance for Loan Losses, and Non-Performing Assets

 

Loans

 

The categories of loans listed below are grouped in accordance with the primary purpose of the loans, but in the aggregate 85.0% and 83.7% of all loans are secured by real estate at March 31, 2016 and December 31, 2015, respectively.

 

   

March 31, 2016

   

December 31, 2015

 
   

Amount

   

Percent

   

Amount

   

Percent

 

(dollars in thousands)

 

Outstanding

   

of Total

   

Outstanding

   

of Total

 

Commercial (1)

  $ 113,048       18.6

%

  $ 112,861       18.9

%

Commercial real estate

    266,037       43.7

%

    259,013       43.3

%

Residential

    124,199       20.4

%

    127,367       21.3

%

Land and construction

    65,091       10.7

%

    59,808       10.0

%

Consumer and other (2)

    40,513       6.6

%

    39,058       6.5

%

Loans, gross

    608,888       100.0

%

    598,107       100.0

%

Net deferred costs

    294               326          

Less — allowance for loan losses

    (9,161

)

            (8,961

)

       

Loans, net

  $ 600,021             $ 589,472          


(1)

Unsecured commercial loan balances were $33.4 million and $34.4 million at March 31, 2016 and December 31, 2015, respectively.

(2)

Unsecured consumer and other loan balances were $10.3 million and $10.6 million at March 31, 2016 and December 31, 2015, respectively.

 

As of March 31, 2016 and December 31, 2015, substantially all of the Company’s loan customers were located in Southern California.

 

 

Allowance for Loan Losses and Recorded Investment in Loans

 

The following is a summary of activities for the allowance for loan losses and recorded investment in loans as of and for the three months ended March 31, 2016 and 2015:

 

 

(in thousands)

 

Commercial

   

Commercial

Real Estate

   

Residential

   

Land and

Construction

   

Consumer

and Other

   

Total

 

Three Months Ended March 31, 2016:

                                         

Allowance for loan losses:

                                               

Beginning balance

  $ 1,807     $ 4,580     $ 907     $ 1,146     $ 521     $ 8,961  

Provision for loan losses

          115       (15

)

    100             200  

Charge-offs

                                   

Recoveries

                                   

Ending balance

  $ 1,807     $ 4,695     $ 892     $ 1,246     $ 521     $ 9,161  

As of March 31, 2016:

                                               

Ending balance: individually evaluated for impairment

  $ 35     $     $     $     $     $ 35  

Ending balance: collectively evaluated for impairment

    1,772       4,695       892       1,246       521       9,126  

Total

  $ 1,807     $ 4,695     $ 892     $ 1,246     $ 521     $ 9,161  

Loans:

                                               

Ending balance: individually evaluated for impairment

  $ 712     $     $     $     $ 46     $ 758  

Ending balance: collectively evaluated for impairment

    112,336       266,037       124,199       65,091       40,467       608,130  

Total

  $ 113,048     $ 266,037     $ 124,199     $ 65,091     $ 40,513     $ 608,888  

Three Months Ended March 31, 2015:

                                         

Allowance for loan losses:

                                               

Beginning balance

  $ 1,752     $ 3,825     $ 747     $ 816     $ 459     $ 7,599  

Provision for loan losses

                10       100       40       150  

Charge-offs

                                   

Recoveries

    16                               16  

Ending balance

  $ 1,768     $ 3,825     $ 757     $ 916     $ 499     $ 7,765  

As of March 31, 2015:

                                               

Ending balance: individually evaluated for impairment

  $ 20     $     $     $     $     $ 20  

Ending balance: collectively evaluated for impairment

    1,748       3,825       757       916       499       7,745  

Total

  $ 1,768     $ 3,825     $ 757     $ 916     $ 499     $ 7,765  

Loans:

                                               

Ending balance: individually evaluated for impairment

  $ 632     $     $     $     $ 49     $ 681  

Ending balance: collectively evaluated for impairment

    98,347       201,375       101,303       46,116       31,989       479,130  

Total

  $ 98,979     $ 201,375     $ 101,303     $ 46,116     $ 32,038     $ 479,811  

 

The following is a summary of the allowance for loan losses and recorded investment in loans as of December 31, 2015:

 

(in thousands)

 

Commercial

   

Commercial

Real Estate

   

Residential

   

Land and

Construction

   

Consumer

and Other

   

Total

 

Allowance for loan losses:

                                               

Ending balance: individually evaluated for impairment

  $ 35     $     $     $     $     $ 35  

Ending balance: collectively evaluated for impairment

    1,772       4,580       907       1,146       521       8,926  

Total

  $ 1,807     $ 4,580     $ 907     $ 1,146     $ 521     $ 8,961  

Loans:

                                               

Ending balance: individually evaluated for impairment

  $ 712     $     $     $     $ 47     $ 759  

Ending balance: collectively evaluated for impairment

    112,149       259,013       127,367       59,808       39,011       597,348  

Total

  $ 112,861     $ 259,013     $ 127,367     $ 59,808     $ 39,058     $ 598,107  

  

 

In addition to the allowance for loan losses, the Company also estimates probable losses related to unfunded lending commitments. Unfunded lending commitments are subject to individual reviews and are analyzed and segregated by product type. These classifications, in conjunction with an analysis of historical loss experience, current economic conditions, performance trends within specific portfolio segments and any other pertinent information, result in the estimation of the reserve for unfunded lending commitments. Provision for credit losses related to unfunded lending commitments is reported in other operating expenses in the unaudited Consolidated Statements of Operations and Comprehensive Income. The allowance held for unfunded lending commitments is reported in accrued interest and other liabilities within the accompanying Consolidated Balance Sheets, and not as part of the allowance for loan losses in the above tables. As of March 31, 2016 and December 31, 2015, the allowance for unfunded lending commitments was $395,000 and $345,000, respectively, and is primarily related to $160.7 million and $159.9 million in commitments to extend credit to customers and $3.1 million and $3.2 million in standby/commercial letters of credit at March 31, 2016 and December 31, 2015, respectively.

 

Non-Performing Assets

 

The following table presents an aging analysis of the recorded investment of past due loans as of March 31, 2016 and December 31, 2015. Payment activity is reviewed by management on a monthly basis to determine the performance of each loan. Loans are considered to be non-performing when a loan is greater than 90 days delinquent. Loans that are 90 days or more past due may still accrue interest if they are well-secured and in the process of collection. There were no additions to non-performing loans during the three months ended March 31, 2016 and 2015. Non-performing loans represented 0.12% of total loans at both March 31, 2016 and December 31, 2015. There were no accruing loans past due 90 days or more at March 31, 2016 and December 31, 2015.

 

(in thousands)

 

30-59

Days Past

Due

   

60-89

Days Past

Due

   

> 90 Days

Past Due

   

Total

Past Due

   

Current

   

Total

 

As of March 31, 2016:

                                               

Commercial

  $     $     $ 712     $ 712     $ 112,336     $ 113,048  

Commercial real estate

                            266,037       266,037  

Residential

                            124,199       124,199  

Land and construction

                            65,091       65,091  

Consumer and other

                            40,513       40,513  

Totals

  $     $     $ 712     $ 712     $ 608,176     $ 608,888  

As of December 31, 2015:

                                               

Commercial

  $     $     $ 712     $ 712     $ 112,149     $ 112,861  

Commercial real estate

                            259,013       259,013  

Residential

                            127,367       127,367  

Land and construction

                            59,808       59,808  

Consumer and other

                            39,058       39,058  

Totals

  $     $     $ 712     $ 712     $ 597,395     $ 598,107  

 

The following table sets forth non-accrual loans and other real estate owned at March 31, 2016 and December 31, 2015:

 

(dollars in thousands)

 

March 31, 2016

   

December 31, 2015

 

Non-accrual loans:

               

Commercial

  $ 712     $ 712  

Total non-accrual loans

    712       712  

Total non-performing assets

  $ 712     $ 712  
                 

Non-performing assets to gross loans and OREO

    0.12

%

    0.12

%

Non-performing assets to total assets

    0.10

%

    0.10

%

 

Credit Quality Indicators

 

The following table represents the credit exposure by internally assigned grades at March 31, 2016 and December 31, 2015. This grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements in accordance with the loan terms. The Company’s internal credit risk grading system is based on management’s experiences with similarly graded loans. Credit risk grades are reassessed each quarter based on any recent developments potentially impacting the creditworthiness of the borrower, as well as other external statistics and factors, which may affect the risk characteristics of the respective loan.

 

 

The Company’s internally assigned grades are as follows:

 

Pass – Strong credit with no existing or known potential weaknesses deserving of management’s close attention.

Special Mention – Potential weaknesses that deserve management’s close attention. Borrower and guarantor’s capacity to meet all financial obligations is marginally adequate or deteriorating.

Substandard – Inadequately protected by the paying capacity of the Borrower and/or collateral pledged. The borrower or guarantor is unwilling or unable to meet loan terms or loan covenants for the foreseeable future.

Doubtful – All the weakness inherent in one classified as Substandard with the added characteristic that those weaknesses in place make the collection or liquidation in full, on the basis of current conditions, highly questionable and improbable.

Loss – Considered uncollectible or no longer a bankable asset. This classification does not mean that the asset has absolutely no recoverable value. In fact, a certain salvage value is inherent in these loans. Nevertheless, it is not practical or desirable to defer writing off a portion or whole of a perceived asset even though partial recovery may be collected in the future.

 

(in thousands)

 

Commercial

   

Commercial Real Estate

   

Residential

   

Land and Construction

   

Consumer and Other

 

As of March 31, 2016:

                                       

Grade:

                                       

Pass

  $ 112,164     $ 266,037     $ 124,199     $ 65,091     $ 40,467  

Special Mention

    172                          

Substandard

    712                         46  

Total

  $ 113,048     $ 266,037     $ 124,199     $ 65,091     $ 40,513  

As of December 31, 2015:

                                 

Grade:

                                       

Pass

  $ 111,970     $ 259,013     $ 127,367     $ 59,808     $ 39,011  

Special Mention

    179                          

Substandard

    712                         47  

Total

  $ 112,861     $ 259,013     $ 127,367     $ 59,808     $ 39,058  

 

There were no loans assigned to the Doubtful or Loss grade as of March 31, 2016 and December 31, 2015.

 

Impaired Loans

 

The following table includes the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable. Management determined the specific allowance based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the remaining source of repayment for the loan is the operation or liquidation of the collateral. In those cases, the current fair value of the collateral, less selling costs was used to determine the specific allowance recorded. Also presented in the table below are the average recorded investments in the impaired loans and the related amount of interest recognized during the time within the period that the impaired loans were impaired. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual status, all payments are applied to principal, under the cost recovery method. When the ultimate collectability of the total principal of an impaired loan is not in doubt and the loan is on non-accrual status, contractual interest is credited to interest income when received, under the cash basis method. The average balances are calculated based on the month-end balances of the loans of the period reported.

 

 

(in thousands)

 

Recorded

Investment

   

Unpaid

Principal

Balance

   

Related

Allowance

   

Average

Recorded

Investment

 

As of and for the three months ended March 31, 2016:

                               

With no related allowance recorded:

                               

Commercial

  $ 572     $ 848     $     $ 572  

Commercial real estate

                       

Residential

                       

Land and construction

                       

Consumer and other

    46       46             47  

With an allowance recorded:

                               

Commercial

  $ 140     $ 155     $ 35     $ 140  

Commercial real estate

                       

Residential

                       

Land and construction

                       

Consumer and other

                       

Totals:

                               

Commercial

  $ 712     $ 1,003     $ 35     $ 712  

Commercial real estate

  $     $     $     $  

Residential

  $     $     $     $  

Land and construction

  $     $     $     $  

Consumer and other

  $ 46     $ 46     $     $ 47  

As of and for the year ended December 31, 2015:

                               

With no related allowance recorded:

                               

Commercial

  $ 572     $ 848     $     $ 572  

Commercial real estate

                       

Residential

                       

Land and construction

                       

Consumer and other

    47       47             48  

With an allowance recorded:

                               

Commercial

  $ 140     $ 155     $ 35     $ 107  

Commercial real estate

                       

Residential

                       

Land and construction

                       

Consumer and other

                       

Totals:

                               

Commercial

  $ 712     $ 1,003     $ 35     $ 679  

Commercial real estate

  $     $     $     $  

Residential

  $     $     $     $  

Land and construction

  $     $     $     $  

Consumer and other

  $ 47     $ 47     $     $ 48  

 

During the three months ended March 31, 2016, the average balance of impaired loans was $759,000, compared to $681,000 for the same period last year. As of both March 31, 2016 and December 31, 2015, there were $712,000 of impaired loans on non-accrual status. For both the three months ended March 31, 2016 and 2015, interest income recognized on impaired loans subsequent to their classification as impaired was $1,000. The Company stops accruing interest on these loans on the date they are classified as non-accrual and reverses any uncollected interest that had been previously accrued as income. The Company may begin recognizing interest income on these loans as cash interest payments are received, if collection of principal is reasonably assured.

 

 

Troubled Debt Restructurings

 

There were no troubled debt restructurings during the three months ended March 31, 2016 and 2015. The impact on the Company’s determination of the allowance for loan losses related to troubled debt restructurings was not material and resulted in no charge-offs during the three months ended March 31, 2016 and 2015. During the three months ended March 31, 2016 and 2015, there were no defaults recorded on any loans that were modified as troubled debt restructurings during the preceding twelve months. A troubled debt restructuring is considered to be in default once it becomes 60 days or more past due following a modification.

 

(4)

Derivative Financial Instruments

 

The fair value of derivative positions outstanding is included in accrued interest receivable and other assets and accrued interest payable and other liabilities in the accompanying Consolidated Balance Sheets and in the net change in each of these financial statement line items in the accompanying unaudited Consolidated Statements of Cash Flows.

 

Interest Rate Derivatives. The Company utilizes interest rate swaps to facilitate the needs of its customers. The Company has entered into interest rate swaps that are not designated as hedging instruments. These derivative contracts relate to transactions in which the Company enters into an interest rate swap with a customer while at the same time entering into an offsetting interest rate swap with another financial institution. In connection with each swap transaction, the Company agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, the Company agrees to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows the Company’s customer to effectively convert a variable rate loan to a fixed rate. Because the Company acts as an intermediary for its customer, changes in the fair value of the underlying derivative contracts for the most part offset each other and do not significantly impact the Company’s results of operations.

 

The notional amounts and estimated fair values of interest rate derivative contracts outstanding at March 31, 2016 and December 31, 2015 are presented in the following table. The Company obtains dealer quotations to value its interest rate derivative contracts.

 

   

March 31, 2016

   

December 31, 2015

 

(in thousands)

 

Notional

Amount

   

Estimated

Fair Value

   

Notional

Amount

   

Estimated

Fair Value

 

Non-hedging interest rate derivatives:

                               

Commercial loan interest rate swaps

  $ 2,019     $ (57

)

  $ 2,032     $ (30

)

Commercial loan interest rate swaps

  $ (2,019

)

  $ 57     $ (2,032

)

  $ 30  

 

The weighted-average rates paid and received for interest rate swaps outstanding at March 31, 2016 and December 31, 2015 were as follow:

 

   

March 31, 2016

Weighted-Average

   

December 31, 2015

Weighted-Average

 
   

Interest

Rate Paid

   

Interest

Rate

Received

   

Interest

Rate Paid

   

Interest

Rate

Received

 

Non-hedging interest rate swaps

    3.68

%

    4.96

%

    3.68

%

    4.96

%

Non-hedging interest rate swaps

    4.96

%

    3.68

%

    4.96

%

    3.68

%

 

Gains, Losses and Derivative Cash Flows. For non-hedging derivative instruments, gains and losses due to changes in fair value and all cash flows are included in other non-interest income and other non-interest expense in the accompanying unaudited Consolidated Statements of Operations and Comprehensive Income.

 

As stated above, the Company enters into non-hedge related derivative positions primarily to accommodate the business needs of its customers. Upon the origination of a derivative contract with a customer, the Company simultaneously enters into an offsetting derivative contract with a third party. The Company recognizes immediate income based upon the difference in the bid/ask spread of the underlying transactions with its customers and the third party. Because the Company acts only as an intermediary for its customer, subsequent changes in the fair value of the underlying derivative contracts for the most part offset each other and do not significantly impact the Company’s results of operations.

 

 

(5)

Comprehensive Income

 

Comprehensive income, which includes net income and the net change in unrealized gains on investment securities available for sale, is presented below:

 

   

Three Months Ended

March 31,

 

(in thousands)

 

2016

   

2015

 

Net income

  $ 273     $ 315  

Other comprehensive income:

               

Increase in net unrealized gains on investment securities available for sale, net of tax expense of $353 and $252 for the three months ended March 31, 2016 and 2015, respectively

    504       361  

Reclassification for net gains included in earnings, net of tax expense of none and $31 for the three months ended March 31, 2016 and 2015, respectively

          (44

)

Comprehensive income

  $ 777     $ 632  

 

Reclassification adjustments of none and $75,000 for the three months ended March 31, 2016 and 2015, respectively, are included in non-interest income within the unaudited Consolidated Statements of Operations and Comprehensive Income. Income tax expense associated with these reclassification adjustments for the three months ended March 31, 2016 and 2015 were none and $31,000, respectively, and is included in income tax provision within the unaudited Consolidated Statements of Operations and Comprehensive Income.

 

Activity of investment securities available for sale included in accumulated other comprehensive income, net of tax, is as follows:

 

   

Three Months Ended

March 31,

 

(in thousands)

 

2016

   

2015

 

Beginning balance

  $ 11     $ 162  

Other comprehensive income before reclassifications

    504       361  

Amounts reclassified from accumulated other comprehensive income

          (44

)

Net other comprehensive income

    504       317  

Ending balance

  $ 515     $ 479  

 

(6)

Premises and Equipment

 

Premises and equipment are stated at cost less accumulated depreciation and amortization. Premises and equipment at March 31, 2016 and December 31, 2015 are comprised of the following:

 

(in thousands)

 

March 31, 2016

   

December 31, 2015

 

Leasehold improvements

  $ 1,901     $ 1,881  

Furniture & equipment

    3,218       3,150  

Software

    978       871  

Total

    6,097       5,902  

Accumulated depreciation

    (4,407

)

    (4,275

)

Premises and equipment, net

  $ 1,690     $ 1,627  

 

Depreciation and amortization included in occupancy expense was $132,000 and $152,000 for the three months ended March 31, 2016 and 2015, respectively.

 

 

(7)

Deposits

 

The following table reflects the summary of deposit categories by dollar and percentage at March 31, 2016 and December 31, 2015:

 

   

March 31, 2016

   

December 31, 2015

 

(dollars in thousands)

 

Amount

   

% of Total

   

Amount

   

% of Total

 

Non-interest bearing demand deposits

  $ 383,486       58.6

%

  $ 362,451       60.6

%

Interest bearing checking

    36,385       5.5

%

    32,406       5.4

%

Money market deposits and savings

    187,381       28.6

%

    155,572       26.0

%

Certificates of deposit

    47,705       7.3

%

    47,748       8.0

%

Total

  $ 654,957       100.0

%

  $ 598,177       100.0

%

 

At March 31, 2016, the Company had two certificates of deposit with the State of California Treasurer’s Office for a total of $46.0 million, which represented 7.0% of total deposits. The deposits outstanding at March 31, 2016 are scheduled to mature in the second quarter of 2016. The Company intends to renew each of these deposits at maturity. However, there can be no assurance that the State of California Treasurer’s Office will continue to maintain deposit accounts with the Company. At December 31, 2015, the Company had two certificates of deposit with the State of California Treasurer’s Office for a total of $46.0 million, which represented 7.7% of total deposits. The Company was required to pledge $50.6 million of investment securities at both March 31, 2016 and December 31, 2015, in connection with these certificates of deposit.

 

The aggregate amount of certificates of deposit of $250,000 or greater was $46.5 million at both March 31, 2016 and December 31, 2015. At March 31, 2016, all certificates of deposit of $250,000 or greater, including deposit accounts with the State of California Treasurer’s Office and Certificate of Deposit Account Registry System (“CDARS”), were scheduled to mature in six months or less.

 

The table below sets forth the range of interest rates, amount and remaining maturities of the certificates of deposit at March 31, 2016.

 

(in thousands)

   

Six months

and less

   

Greater than six

months through

one year

   

Greater than

one year

 
0.00% to 0.99%     $ 47,422     $ 186     $ 69  
1.00% to 1.99%                   28  

Total

    $ 47,422     $ 186     $ 97  


(8)

Other Borrowings

 

At March 31, 2016 and December 31, 2015, the Company had a borrowing/credit facility secured by a blanket lien on eligible loans at the FHLB of $183.0 million and $180.0 million, respectively. The Company had $15.0 million of long-term borrowings outstanding under this borrowing/credit facility with the FHLB at both March 31, 2016 and December 31, 2015. The Company had no overnight borrowings outstanding under this borrowing/credit facility at March 31, 2016. During the three months ended March 31, 2016, the Company had an average short-term borrowing balance of $4.0 million under this credit facility, incurring $6,000 in interest expense during this period. At December 31, 2015, the Company had a $50.0 million overnight borrowing outstanding under this borrowing/credit facility at an interest rate of 0.27%. The Company did not incur any material interest expense in connection with this borrowing and it was repaid in January 2016.

 

The following table summarizes the outstanding long-term borrowings under the borrowing/credit facility secured by a blanket lien on eligible loans at the FHLB at March 31, 2016 and December 31, 2015 (dollars in thousands):

 

Maturity Date

 

Interest Rate

   

March 31, 2016

   

December 31, 2015

 

May 23, 2016

    2.07%       2,500       2,500  

December 29, 2016

    1.38%       5,000       5,000  

December 30, 2016

    1.25%       2,500       2,500  

May 2, 2018

    0.93%       5,000       5,000  
   

Total

    $ 15,000     $ 15,000  

 

At March 31, 2016 and December 31, 2015, the Company also had $27.0 million in Federal fund lines of credit available with other correspondent banks that could be used to disburse loan commitments and to satisfy demands for deposit withdrawals. Each of these lines of credit is subject to conditions that the Company may not be able to meet at the time when additional liquidity is needed. As of both March 31, 2016 and December 31, 2015, the Company had pledged $2.3 million, of investments related to these lines of credit.

 

  

(9)

Commitments and Contingencies

 

Commitments to Extend Credit

 

The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby/commercial letters of credit and guarantees on revolving credit card limits. These instruments involve various levels and elements of credit and interest rate risk in excess of the amount recognized in the accompanying consolidated financial statements. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company had $160.7 million and $159.9 million in commitments to extend credit to customers and $3.1 million and $3.2 million in standby/commercial letters of credit at March 31, 2016 and December 31, 2015, respectively. The Company also guarantees the outstanding balance on credit cards offered at the Company, but underwritten by another financial institution. The outstanding balances on these credit cards were $105,000 and $82,000 as of March 31, 2016 and December 31, 2015, respectively.

 

Lease Commitments

 

The Company leases office premises under three operating leases that will expire in December 2018, May 2019 and June 2024, respectively. Rental expense, which is included in occupancy expense, was $265,000 and $266,000 for the three months ended March 31, 2016 and 2015, respectively.

 

The projected minimum rental payments under the term of the leases at March 31, 2016 are as follows (in thousands):

 

Years ending December 31,

       

2016 (April-December)

  $ 742  

2017

    1,015  

2018

    1,046  

2019

    834  

2020

    760  

Thereafter

    2,840  

Total

  $ 7,237  

 

Litigation

 

The Company from time to time is party to lawsuits, which arise out of the normal course of business. At March 31, 2016 and December 31, 2015, the Company did not have any litigation that management believes will have a material impact on the Consolidated Balance Sheets or unaudited Consolidated Statements of Operations and Comprehensive Income.

 

Restricted Stock

 

The following table sets forth the Company’s future restricted stock expense, net of estimated forfeitures (in thousands).

 

Years ending December 31,

       

2016 (April-December)

  $ 712  

2017

    582  

2018

    351  

2019

    200  

2020

    137  

Thereafter

    30  

Total

  $ 2,012  

 

 

(

10)

Fair Value Measurements

 

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of March 31, 2016 and December 31, 2015, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

 

 

Assets and Liabilities Measured on a Recurring Basis

 

Assets and liabilities measured at fair value on a recurring basis are summarized below:

 

           

Fair Value Measurements Using

 

(in thousands)

 

Fair Value

   

Quoted Prices in

Active Markets for

Identical Assets (Level 1)

   

Other Observable

Inputs (Level 2)

   

Significant Unobservable

Inputs (Level 3)

 

At March 31, 2016:

                               

Investments-Available for Sale

                               

U.S. Treasuries and Government Agencies

  $ 35,086     $ 3,973     $ 31,113     $  

Residential Mortgage-Backed Securities

    37,378             37,378        

Derivative Assets – Interest Rate Swaps

    57             57        

Derivative Liabilities – Interest Rate Swaps

    57             57        

At December 31, 2015:

                               

Investments-Available for Sale

                               

U.S. Treasuries and Government Agencies

  $ 34,599     $ 3,910     $ 30,689     $  

Residential Mortgage-Backed Securities

    39,411             39,411        

Derivative Assets – Interest Rate Swaps

    30             30        

Derivative Liabilities – Interest Rate Swaps

    30             30        

 

AFS securities — As of March 31, 2016 and December 31, 2015, the Level 2 fair value of the Company’s residential mortgage-backed securities was $37.4 million and $39.4 million, respectively. These securities consist primarily of agency mortgage-backed securities issued by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. The underlying loans for these securities are residential mortgages that were primarily originated beginning in the year of 2005 through 2014. These loans are geographically dispersed throughout the United States. At March 31, 2016 and December 31, 2015, the weighted average yield and weighted average life of these securities were 1.78% and 1.79%, respectively, and 3.26 years and 3.36 years, respectively.

 

The valuation for investment securities utilizing Level 2 inputs were primarily determined by quotes received from an independent pricing service using matrix pricing, which is a mathematical technique widely used in the industry to value securities without relying exclusively on quoted market prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities. There were no transfers into or out of Level 1 or 2 measurements during the three months ended March 31, 2016 and 2015.

 

Assets Measured on a Non-Recurring Basis

 

Assets measured at fair value on a non-recurring basis are summarized below:

 

           

Fair Value Measurements Using

 

(in thousands)

 

Fair Value

   

Quoted Prices in

Active Markets for

Identical Assets

(Level 1)

   

Other Observable

Inputs

(Level 2)

   

Significant

Unobservable

Inputs (Level 3)

 

At March 31, 2016:

                               

Impaired loans

                               

Commercial

  $ 677     $     $     $ 677  

At December 31, 2015:

                               

Impaired loans

                               

Commercial

  $ 677     $     $     $ 677  

 

 

Impaired loans — At the time a loan is considered impaired, it is valued at the lower of cost or fair value. The fair value of impaired loans that are collateral dependent is determined using various valuation techniques which are not readily observable in the market place, including consideration of appraised values and other pertinent real estate market data. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

 

 

 

(11)

Estimated Fair Value Information

 

The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many cases, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Estimated fair value amounts have been determined by using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amounts the Company could realize in a current market exchange.

 

The methods and assumptions used to estimate the fair value of each class of financial instruments for which it is practicable to estimate the value are explained below.

 

Cash and cash equivalents

 

The carrying amounts are considered to be their estimated fair values and are classified as Level 1 because of the short-term maturity of these instruments which includes Federal funds sold and interest-earning deposits at other financial institutions.

 

Investment securities

 

AFS investment securities are carried at fair value, which are based on quoted prices of exact or similar securities, or on inputs that are observable, either directly or indirectly. The Company obtains quoted prices through third party brokers. Investment securities are classified as Level 1 to the extent that they are based on quoted prices for identical instrument traded in active markets. Investment securities are classified as Level 2 for valuations based on quotes prices for similar securities or inputs that are observable, either directly or indirectly.

 

FRB and FHLB stock

 

It is not practical to determine the fair value of FRB and FHLB stock due to restrictions placed on its transferability.

 

Loans, net

 

For loans, the fair value is estimated using market quotes for similar assets or the present value of future cash flows, discounted using the current rate at which similar loans would be made to borrowers with similar credit ratings and for the same maturities and giving consideration to estimated prepayment risk and credit risk. The fair value of loans is determined utilizing estimates resulting in a Level 3 classification.

 

Impaired loans are measured for impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Company may measure impairment based on a loan’s observable market price, or the fair value of the collateral (net of estimated costs to sell) if the loan is collateral dependent. The fair value of impaired loans is determined utilizing estimates resulting in a Level 3 classification.

 

Off-balance sheet credit-related instruments

 

The fair values of commitments, which include standby letters of credit and commercial letters of credit, are based upon fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The related fees are not considered material to the Company’s financial statements as a whole and the fair market value of the Company’s off-balance sheet credit-related instruments cannot be readily determined. The fair value of these items is determined utilizing estimates resulting in a Level 3 classification.

 

Derivatives

 

The fair value of derivatives is based on valuation models using observable market data as of the measurement date and is classified as Level 2.

 

Deposits

 

For demand deposits, the carrying amount approximates fair value. The fair values of interest bearing checking, savings, and money market deposits are estimated by discounting future cash flows using the interest rates currently offered for deposits of similar products. Because of the short-term maturity of these deposits, the carrying amounts are considered to be their estimated fair values and are classified as Level 1.

 

 

The fair values of the certificates of deposit are estimated by discounting future cash flows based on the rates currently offered for certificates of deposit with similar interest rates and remaining maturities. The fair value of certificates of deposit is determined utilizing estimates resulting in a Level 2 classification.

 

Other borrowings

 

The fair values of long term FHLB advances are estimated based on the rates currently offered by the FHLB for advances with similar interest rates and remaining maturities. The fair value of other borrowings is determined utilizing estimates resulting in a Level 2 classification.

 

Accrued interest

 

The estimated fair value for both accrued interest receivable and accrued interest payable are considered to be equivalent to the carrying amounts, resulting in a Level 1 classification.

 

The estimated fair value and carrying amounts of the financial instruments at March 31, 2016 and December 31, 2015 are as follows:

 

    Carrying     Fair Value Measurements Using  

(dollars in thousands)

 

Amount

   

Level 1

   

Level 2

   

Level 3

   

Total

 

As of March 31, 2016

                                       

Assets

                                       

Cash and cash equivalents

  $ 52,384     $ 52,384     $     $     $ 52,384  

Investment securities

    72,464       3,973       68,491             72,464  

FRB stock

    1,855                         N/A  

FHLB stock

    3,167                         N/A  

Loans, net

    600,021                   598,690       598,690  

Non-hedging interest rate swaps

    57             57             57  

Accrued interest receivable

    1,800       1,800                   1,800  

Liabilities

                                       

Non-interest bearing deposits

  $ 383,486     $ 383,486     $     $     $ 383,486  

Interest bearing deposits

    271,471       223,766       47,705             271,471  

Other borrowings

    15,000             15,026             15,026  

Non-hedging interest rate swaps

    57             57             57  

Accrued interest payable

    36       36                   36  

As of December 31, 2015

                                       

Assets

                                       

Cash and cash equivalents

  $ 54,565     $ 54,565     $     $     $ 54,565  

Investment securities

    74,010       3,910       70,100             74,010  

FRB stock

    1,748                         N/A  

FHLB stock

    3,167                         N/A  

Loans, net

    589,472                   587,530       587,530  

Non-hedging interest rate swaps

    30             30             30  

Accrued interest receivable

    1,692       1,692                   1,692  

Liabilities

                                       

Non-interest bearing deposits

  $ 362,451     $ 362,451     $     $     $ 362,451  

Interest bearing deposits

    235,726       187,978       47,748             235,726  

Other borrowings

    65,000             64,983             64,983  

Non-hedging interest rate swaps

    30             30             30  

Accrued interest payable

    23       23                   23  

  

 

(12)

Non-Interest Income

 

The following table summarizes the information regarding non-interest income for the three months ended March 31, 2016 and 2015, respectively:

 

   

Three Months Ended

March 31,

 

(in thousands)

 

2016

   

2015

 

Gain on sale of AFS investment securities

  $     $ 75  

Service charges and other operating income

    198       155  

Total non-interest income

  $ 198     $ 230  

 

(13)

Stock-Based Compensation

 

On May 8, 2013, the stockholders of the Company approved the Company’s 2013 Equity Incentive Plan (the “Plan”), which provides for the grant of up to 750,000 shares of Common Stock to employees, including officers and directors, non-employee directors and consultants. Stock options, stock appreciation rights, restricted stock and other stock awards, and restricted stock units are all available for grant pursuant to the terms and conditions of the Plan. The Plan was established to consolidate and replace all other previous stock plans and the remaining shares available for grant under these previous plans were cancelled.

 

Prior to the approval of the Plan, the Company granted restricted stock awards to directors and employees under the 2005 Equity Incentive Plan. Restricted stock awards are considered fixed awards as the number of shares and fair value is known at the date of grant and the fair value at the grant date is amortized over the requisite service period.

 

Non-cash stock compensation expense recognized in the unaudited Consolidated Statements of Operations and Comprehensive Income related to the restricted stock awards, net of estimated forfeitures, was $272,000 and $224,000 for the three months ended March 31, 2016 and 2015, respectively. The fair value of restricted stock awards that vested was $130,000 and $145,000 for the three months ended March 31, 2016 and 2015, respectively.

 

The following table reflects a combined summary of the activities related to restricted stock awards outstanding for the three months ended March 31, 2016 and 2015, respectively.

 

   

Three Months Ended March 31,

 
   

2016

   

2015

 

Restricted Shares

 

Number
of
Shares

   

Weighted Avg

Fair Value at
Grant
Date

   

Number
of
Shares

   

Weighted Avg

Fair Value at
Grant
Date

 

Beginning balance

    669,750     $ 6.56       615,875     $ 5.92  

Granted

    18,000       7.50       26,000       6.50  

Vested

    (20,000

)

    6.50       (20,000

)

    7.24  

Forfeited and surrendered

                       

Ending balance

    667,750     $ 6.59       621,875     $ 5.90  

 

The Company recognizes compensation expense for stock options by amortizing the fair value at the grant date over the service, or vesting period.

 

There have been no options granted, exercised or outstanding under the Director and Employee Stock Option Plan as of and for the three months ended March 31, 2016. There were no options granted or exercised under the Director and Employee Stock Option Plan for the three months ended March 31, 2015. The remaining contractual life of the Director and Employee Stock Options outstanding was 0.34 years at March 31, 2015. All options under the Directors and Employee Stock Option Plan were exercisable at March 31, 2015. At March 31, 2015, the weighted average exercise price of the 350,073 shares outstanding under the Director and Employee Stock Option Plan was $8.06. During the year ended December 31, 2015, 42,500 of unexercised option under the plan expired and were automatically cancelled. The weighted average exercise price of the cancelled options was $8.40 per share.

 

 

The following tables detail the amount of shares authorized and available under all stock plans as of March 31, 2016:

 

   

Shares Reserved

   

Less Shares Previously
Exercised/Vested

   

Less Shares
Outstanding

   

Total Shares
Available for
Future Issuance

 

2004 Founder Stock Option Plan

    150,000       121,900              
                                 

Director and Employee Stock Option Plan

    1,434,000       1,220,097              
                                 

2005 Equity Incentive Plan

    1,200,000       944,273       243,000        
                                 

2013 Equity Incentive Plan

    750,000       40,000       424,750       285,250  

 

(14)

Regulatory Matters

 

Capital

 

Bancshares and the Bank are subject to the various regulatory capital requirements administered by federal banking agencies. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bancshares and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Failure to meet minimum capital requirements can initiate certain mandatory – and possibly additional discretionary – actions by regulators that, if undertaken, could have a direct material effect on the financial statements of the Company.

 

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulation) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes that as of March 31, 2016 and December 31, 2015, the Company and the Bank met all capital adequacy requirements to which they are subject.

 

At December 31, 2015, the most recent notification from the OCC categorized the Bank as “well-capitalized” under the regulatory framework for prompt corrective action. To generally be categorized as a “well-capitalized” financial institution, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios. There are no conditions or events since the notification that management believes have changed the Bank’s categorization.

 

The Company’s and the Bank’s capital ratios as of March 31, 2016 and December 31, 2015 are presented in the table below:

 

   

Company

   

Bank

   

For Capital
Adequacy Purposes

   

For the Bank to be
Well-Capitalized Under
Prompt Corrective
Measures

 

(dollars in thousands)

 

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

 

March 31, 2016:

                                                               

Total Risk-Based Capital Ratio

  $ 73,675       11.20

%

  $ 73,173       11.13

%

  $ 52,618       8.00

%

  $ 65,772       10.00

%

Tier 1 Risk-Based Capital Ratio

  $ 65,437       9.95

%

  $ 64,935       9.87

%

  $ 39,464       6.00

%

  $ 52,618       8.00

%

Common Equity Tier 1 Capital Ratio

  $ 65,437       9.95

%

  $ 64,935       9.87

%

  $ 29,598       4.50

%

  $ 42,752       6.50

%

Tier 1 Leverage Ratio

  $ 65,437       9.22

%

  $ 64,935       9.14

%

  $ 28,401       4.00

%

  $ 35,523       5.00

%

December 31, 2015:

                                                               

Total Risk-Based Capital Ratio

  $ 73,029       11.24

%

  $ 72,520       11.16

%

  $ 51,992       8.00

%

  $ 64,989       10.00

%

Tier 1 Risk-Based Capital Ratio

  $ 64,891       9.98

%

  $ 64,381       9.91

%

  $ 38,994       6.00

%

  $ 51,991       8.00

%

Common Equity Tier 1 Capital Ratio

  $ 64,891       9.98

%

  $ 64,381       9.91

%

  $ 29,245       4.50

%

  $ 42,243       6.50

%

Tier 1 Leverage Ratio

  $ 64,891       9.00

%

  $ 64,381       8.92

%

  $ 28,852       4.00

%

  $ 36,078       5.00

%

 

On July 2, 2013, the Federal Reserve approved the final rules implementing the Basel Committee on Banking Supervision's (“BCBS”) capital guidelines for U.S. banks. Under the final rules, minimum requirements will increase for both the quantity and quality of capital held by the Company. The rules include a new common equity Tier 1 capital to risk-weighted assets ratio of 4.5%. The new rules also require a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets over each of the required capital ratios that will be phased in from 2016 to 2019 and must be met to avoid limitations the ability of the Bank to pay dividends, repurchase shares or pay discretionary bonuses. During 2016, the phased-in portion of the capital conservation buffer is 0.625%. The final rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and require a minimum leverage ratio of 4.0%. The final rules also implement strict eligibility criteria for regulatory capital instruments, excluding trust preferred securities, mortgage servicing rights and certain deferred tax assets, and including unrealized gains and losses on available for sale debt and equity securities. On July 9, 2013, the FDIC and OCC also approved, as an interim final rule, the regulatory capital requirements for U.S. banks, following the actions of the FRB. The FDIC and OCC's rules are identical in substance to the final rules issued by the FRB.

 

 

The phase-in period for the final rules commenced for the Company and the Bank on January 1, 2015, with full compliance with all of the final rule's requirements phased in over a multi-year schedule.

 

Dividends

 

In the ordinary course of business, Bancshares is dependent upon dividends from the Bank to provide funds for the payment of dividends to stockholders and to provide for other cash requirements. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits for that year combined with the retained net profits for the preceding two years. Currently, the Bank is prohibited from paying dividends to Bancshares until such time as the accumulated deficit is eliminated.

 

To date, Bancshares has not paid any cash dividends. Payment of stock or cash dividends in the future will depend upon earnings and financial condition and other factors deemed relevant by Bancshares’ Board of Directors, as well as Bancshares’ legal ability to pay dividends. Accordingly, no assurance can be given that any cash dividends will be declared in the foreseeable future.

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

      

Introduction

 

Our profitability, like most banks, is primarily dependent on interest rate differentials. In general, the difference between the interest rates paid by us on interest bearing liabilities, such as deposits and other borrowings, and the interest rates received by us on our interest-earning assets, such as loans extended to our clients and securities held in our investment portfolio, comprises the major portion of our earnings. In addition, we may, from time to time, supplement our earnings by monetizing gains in our investment portfolio.

 

Proposed Merger with Midland Financial Co.

 

On March 10, 2016, Bancshares entered into an Agreement and Plan of Merger (the “Merger Agreement”), with Midland Financial Co., an Oklahoma corporation (“Midland”), and MC 2016 Corp., a Delaware corporation and wholly-owned subsidiary of Midland (“Merger Sub”), pursuant to which, upon the terms and subject to the conditions set forth therein, Merger Sub will merge (the “Merger”) with and into Bancshares, with Bancshares surviving the Merger as a wholly-owned subsidiary of Midland. Simultaneously with the Merger, 1st Century Bank will merge (the “Bank Merger”) with and into MidFirst Bank, a federally-chartered savings association and a wholly-owned subsidiary of Midland (“MidFirst”), with MidFirst surviving the Bank Merger. Immediately after the Merger and Bank Merger described above, Bancshares, as the surviving corporation in the Merger, will merge with and into Midland, with Midland as the surviving corporation.

 

Subject to the terms and conditions set forth in the Merger Agreement, upon consummation of the Merger, each outstanding share of Bancshares common stock, par value $0.01 per share, excluding shares owned by Midland, Bancshares or either of their subsidiaries (subject to certain exceptions) or shares owned by stockholders who have validly made and not effectively withdrawn a demand for appraisal rights, will be converted into the right to receive $11.22 in cash.

 

In addition, each share of Bancshares common stock subject to vesting, repurchase, transfer or other lapse restrictions pursuant to any of our benefit plans that is outstanding immediately prior to the effective time of the Merger will vest in full and become free of such restrictions and any repurchase right will lapse, and the holder thereof will be entitled to receive $11.22 in cash with respect to each such restricted share.

 

Consummation of the Merger is subject to certain closing conditions, including: (i) the adoption of the Merger Agreement by the holders of a majority of the outstanding shares of Bancshares common stock as of the applicable record date; (ii) the receipt of certain regulatory approvals required from the Federal Reserve and the OCC without the imposition of a Burdensome Condition (as defined in the Merger Agreement); and (iii) the absence of any law or order prohibiting the Merger or the other transactions contemplated by the Merger Agreement. The obligation of each party to consummate the Merger is also conditioned upon the accuracy of the other party’s representations and warranties (subject to customary materiality qualifiers) and the other party’s performance in all material respects of its obligations contained in the Merger Agreement.

 

 

In addition, the obligation of Midland to consummate the Merger is further conditioned on (i) the absence of a Company Material Adverse Effect (as defined in the Merger Agreement) with respect to the Company and (ii) certain conditions regarding (A) the continued employment of our Chief Executive Officer and Chief Operating Officer and (B) such officers’ compliance with obligations under the employment agreements entered into with MidFirst concurrently with the execution and delivery of the Merger Agreement.

 

Midland and Bancshares have made customary representations, warranties and covenants in the Merger Agreement. Subject to certain exceptions, Bancshares and Midland have agreed to use their respective reasonable best efforts to obtain necessary regulatory approvals. In addition, Bancshares has agreed, among other things, to covenants relating to (i) the conduct of our business during the interim period between the execution of the Merger Agreement and the consummation of the Merger, (ii) facilitating our stockholders’ consideration of, and voting upon, the adoption of the Merger Agreement and certain related matters as applicable, (iii) the recommendation by the board of directors of Bancshares (the “Board”) in favor of the adoption by our stockholders of the Merger Agreement and certain related matters as applicable and (iv) non-solicitation obligations relating to alternative business combination transactions, subject to certain exceptions to allow the Board to exercise its fiduciary duties as set forth in the Merger Agreement.

 

The Merger Agreement contains certain termination rights for both Midland and Bancshares, including if (i) the necessary regulatory approvals are denied or the consummation of the Merger is legally prohibited or enjoined, (ii) the Merger is not consummated by March 10, 2017, (iii) there has been a breach by the other party that is not cured such that the applicable closing conditions are not satisfied, or (iv) the approval of our stockholders is not obtained. Subject to certain conditions, Bancshares may terminate the Merger Agreement prior to stockholder approval of the Merger to enter into a transaction which constitutes a superior proposal. Upon termination of the Merger Agreement under specified circumstances, Bancshares may be required to pay Midland a termination fee of $4,500,000 or reimburse certain of Midland’s expenses up to $1,000,000 (which reimbursement will reduce, on a dollar for dollar basis, any termination fee subsequently payable by Bancshares).

 

Midland and Bancshares currently expect that the Merger will be completed during the second half of 2016 or sooner. However, it is possible that factors outside the control of both companies, including whether or when the required regulatory approvals will be received, could result in the Merger being completed at a different time or not at all. The Company recorded $861,000 in merger-related expenses during the three months ended March 31, 2016.

 

For additional information related to the Merger and the Merger Agreement, please refer to our Current Report on Form 8-K filed with the Securities and Exchange Commission on March 11, 2016 and our preliminary proxy statement filed with the Commission on April 8, 2016. The description of the Merger Agreement and the Merger herein does not purport to be complete and is subject to, and qualified in its entirety by the full text of the Merger Agreement attached as Exhibit 2.1 to the Current Report filed on March 11, 2016.

 

Critical Accounting Policies and Estimates

 

The accounting and reporting policies followed by us conform, in all material respects, to accounting principles generally accepted in the United States, or GAAP, and to general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While we base our estimates on historical experience, current information and other factors deemed by us to be relevant, actual results could differ materially and adversely from those estimates.

 

We consider accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our financial statements. Accounting polices related to the allowance for loan losses (“ALL”) and income taxes are considered to be critical, as these policies involve considerable subjective judgment and estimation by management. Critical accounting policies, and our procedures related to these policies, are summarized below. There have been no changes to our critical accounting policies and estimates during the three months ended March 31, 2016.

 

Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses charged to operations and represents an estimate of probable incurred losses inherent in the Company’s loan portfolio that have been incurred as of the balance sheet date. Loan losses are charged against the allowance when management believes that principal is uncollectible. Subsequent repayments or recoveries, if any, are credited to the allowance. Management periodically assesses the adequacy of the allowance for loan losses by reference to quantitative and qualitative factors that may be weighted differently at various times depending on prevailing conditions. The provisions reflect management’s evaluation of the adequacy of the allowance based, in part, upon the historical loss experience of the loan portfolio, as well as estimates from historical peer group loan loss data and the loss experience of other financial institutions, augmented by management judgment. During this process, loans are separated into the following portfolio segments: commercial, commercial real estate, residential, land and construction, and consumer and other loans. The relative significance of risk considerations vary by portfolio segment. For commercial loans, commercial real estate loans and land and construction loans, the primary risk consideration is a borrower’s ability to generate sufficient cash flows to repay their loan. Secondary considerations include the creditworthiness of guarantors and the valuation of collateral. In addition to the creditworthiness of a borrower, the type and location of real estate collateral is an important risk factor for commercial real estate and land and construction loans. The primary risk consideration for residential loans and consumer loans are a borrower’s personal cash flow and liquidity, as well as collateral value.

 

 

Loss ratios for all portfolio segments are evaluated on a quarterly basis. Loss ratios associated with historical loss experience are determined based on a rolling migration analysis of each portfolio segment within the portfolio. This migration analysis estimates loss factors based on the performance of each portfolio segment over a four and a half year time period. These loss ratios are then adjusted, if determined necessary by management, based on other factors including, but not limited to, historical peer group loan loss data and the loss experience of other financial institutions. Management carefully monitors changing economic conditions, the concentrations of loan categories, values of collateral, the financial condition of the borrowers, the history of the loan portfolio, and historical peer group loan loss data to determine the adequacy of the allowance for loan losses. As a part of this process, management typically focuses on loan-to-value (“LTV”) percentages to assess the adequacy of loss ratios of collateral dependent loans within each portfolio segment discussed above, trends within each portfolio segment, as well as general economic and real estate market conditions where the collateral and borrower are located. For loans that are not collateral dependent, which generally consist of commercial and consumer and other loans, management typically focuses on general business conditions where the borrower operates, trends within the portfolio, and other external factors to evaluate the severity of loss factors. The allowance is based on estimates and actual losses may vary materially and adversely from the estimates.

 

In addition, regulatory agencies, as a part of their examination process, periodically review the Bank’s allowance for loan losses, and may require the Bank to make additions to the allowance through provisioning based on their judgment about information available to them at the time of their examinations. No assurance can be given that adverse future economic conditions will not lead to increased delinquent loans, and increases in the provision for loan losses and/or charge-offs. See Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations Allowance for Loan Losses” for further details considered by management in estimating the necessary level of the allowance for loan losses.

 

Income Taxes. Provision for income taxes is the amount of estimated tax due reported on our tax returns and the change in the amount of deferred tax assets and liabilities. Deferred income taxes represent the estimated net income tax expense payable (or benefits receivable) for temporary differences between the carrying amounts for financial reporting purposes and the amounts used for tax purposes. A valuation allowance is required if it is “more likely than not” that a deferred tax asset will not be realized. The determination of the realizability of deferred tax assets is highly subjective and dependent upon management’s evaluation of both positive and negative evidence, including historic financial performance, forecasts of future income, existence of feasible tax planning strategies, length of statutory carryforward period, and assessments of current and future economic and business conditions. Management evaluates the positive and negative evidence and determines the realizability of the deferred tax asset, and the corresponding need for or adequacy of a valuation allowance on a quarterly basis. See Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Deferred Tax Asset” for further discussion of our deferred tax asset and management’s evaluation of the same.

 

Summary of Financial Condition and Results of Operations

 

For the quarter ended March 31, 2016, the Company recorded net income of $273,000, or $0.03 per diluted share, compared to $315,000, or $0.03 per diluted share, for the same period last year. The decrease in net income during the three months ended March 31, 2016 as compared to the same period last year was primarily due to a $1.8 million increase in non-interest expenses, caused primarily by expenses of $861,000 and $268,000 incurred in connection with the proposed merger with Midland Financial Co. and the pre-effective registration statement that was filed with the U.S. Securities and Exchange Commission on September 25, 2015, respectively. The decrease in net income was partially offset by an increase in net interest income of $1.8 million, primarily resulting from an increase in the average balance of loans during the current quarter as compared to the same period last year.

 

Total assets at March 31, 2016 were $739.5 million, representing an increase of $7.5 million, or 1.0%, from $732.0 million at December 31, 2015. Cash and cash equivalents at March 31, 2016 were $52.4 million, representing a decrease of $2.2 million, or 4.0%, from $54.6 million at December 31, 2015. Loans increased by $10.7 million, from $598.4 million at December 31, 2015 to $609.2 million at March 31, 2016. Loan originations were $61.7 million during the quarter ended March 31, 2016, compared to $61.4 million during the same period last year. Prepayment speeds for the quarter ended March 31, 2016 were 15.9%, compared to 11.0% for the same period last year. Investment securities were $72.5 million at March 31, 2016, compared to $74.0 million at December 31, 2015, representing a decline of $1.5 million, or 2.0%. The weighted average life of our investment securities was 3.70 years and 3.85 years at March 31, 2016 and December 31, 2015, respectively.

 

 

Total liabilities at March 31, 2016 increased by $6.5 million, or 1.0%, to $673.5 million compared to $667.0 million at December 31, 2015. This increase is primarily due to a $56.8 million increase in deposits, partially offset by the repayment of a $50.0 million in overnight borrowing with the FHLB that was outstanding at December 31, 2015. Total core deposits, which includes non-interest bearing demand deposits, interest bearing demand deposits and money market deposits and savings, were $607.3 million and $550.4 million at March 31, 2016 and December 31, 2015, respectively, representing an increase of $56.9 million, or 10.3%.

 

Average interest earning assets increased $113.1 million, from $587.9 million for the three months ended March 31, 2015 to $701.0 million for the three months ended March 31, 2016. The increase in average interest earning assets was primarily due to a $149.1 million increase in average loans during the three months ended March 31, 2016 as compared to the same period last year. The weighted average interest rate on interest earning assets was 4.00% and 3.57% for the three months ended March 31, 2016 and 2015, respectively. The improvement in this rate was primarily attributable to an increase in the average balance of loans relative to total average earning assets as compared to the same period last year, as well as a 14 basis point increase in our loan yield.

 

Average interest bearing deposits and borrowings increased $40.5 million, from $234.0 million for the three months ended March 31, 2015 to $274.6 million for the three months ended March 31, 2016. The increase in average interest bearing deposits and borrowings was primarily due to a $35.9 million increase in average interest bearing deposits during the three months ended March 31, 2016 as compared to the same period last year. The average cost of interest bearing deposits and borrowings was 0.29% during the three months ended March 31, 2016 compared to 0.27% for the same period last year.

 

At March 31, 2016, stockholders’ equity totaled $66.0 million, or 8.9% of total assets, as compared to $64.9 million, or 8.9% of total assets at December 31, 2015. The Company’s book value per share of common stock was $6.38 as of March 31, 2016, compared to $6.15 and $6.29 per share as of March 31, 2015 and December 31, 2015, respectively.

 

Set forth below are certain key financial performance ratios and other financial data for the period indicated:

 

   

Three Months Ended March 31,

 
   

2016

   

2015

 

Annualized return on average assets

    0.15

%

    0.22

%

                 

Annualized return on average stockholders’ equity

    1.67

%

    2.06

%

                 

Average stockholders’ equity to average assets

    9.25

%

    10.44

%

                 

Net interest margin

    3.89

%

    3.46

%

 

Results of Operations

 

Net Interest Income

 

The management of interest income and interest expense is fundamental to the performance of the Company. Net interest income, which is the difference between interest income on interest earning assets, such as loans and investment securities, and interest expense on interest bearing liabilities, such as deposits and other borrowings, is the largest component of the Company’s total revenue. Management closely monitors both net interest income and net interest margin (net interest income divided by average earning assets).

 

Net interest income and net interest margin are affected by several factors including (1) the level of, and the relationship between the dollar amount of interest earning assets and interest bearing liabilities; and (2) the relationship between re-pricing or maturity of our variable-rate and fixed-rate loans, securities, deposits and borrowings.

 

The majority of the Company’s loans are indexed to the national prime rate. Movements in the national prime rate have a direct impact on the Company’s loan yield and interest income. The national prime rate, which generally follows the targeted federal funds rate, was 3.50% and 3.25% at March 31, 2016 and 2015, respectively. In December 2015, the targeted federal funds rate was increased from 0.00%-0.25% to 0.25%-0.50%. During the quarters ended March 31, 2016 and 2015, the targeted federal funds rate were 0.25%-0.50% and 0.00%-0.25%, respectively.

 

The Company, through its asset and liability management policies and practices, seeks to maximize net interest income without exposing the Company to a level of interest rate risk deemed excessive by management. Interest rate risk is managed by monitoring the pricing, maturity and re-pricing characteristics of all classes of interest bearing assets and liabilities.

 

 

During the quarter ended March 31, 2016, net interest income was $6.8 million compared to $5.0 million for the same period last year. The increase in net interest income was primarily attributable to a 41 basis point improvement in our net interest spread. This increase in net interest spread was due to increases in the average balances of our loan portfolio during the quarter ended March 31, 2016 as compared to the same period last year, as well as a 14 basis point increase in our loan yield. The average balance of our loan portfolio was $603.8 million during the quarter ended March 31, 2016, compared to $454.7 million for the same period last year.

 

The Company’s net interest spread was 3.71% for the three months ended March 31, 2016 compared to 3.30% for the same period last year.

 

The Company’s net interest margin was 3.89% for the quarter ended March 31, 2016, compared to 3.46% for the same period last year. The 43 basis point increase in net interest margin is primarily due to an increase in the average balance of loans relative to total average earning assets as compared to the same period last year, as well as a 14 basis point increase in our loan yield. The percentage of average loans to total average earning assets increased to 86.1% during the quarter ended March 31, 2016, compared to 77.3% during the same period last year.

 

The following table sets forth the average balances of certain assets, interest income/expense, average yields on interest earning assets, average rates paid on interest bearing liabilities, net interest margins and net interest income/spread for the three months ended March 31, 2016 and 2015, respectively.

 

   

Three Months Ended March 31,

 
   

2016

   

2015

 
   

Average

   

Interest

           

Average

   

Interest

         

(dollars in thousands)

 

Balance

   

Inc/Exp

   

Yield

   

Balance

   

Inc/Exp

   

Yield

 

Assets

                                               

Interest earning deposits at other financial institutions

  $ 18,626     $ 23       0.50

%

  $ 49,792     $ 32       0.26

%

U.S. Treasuries and Gov’t agencies

    35,004       162       1.86

%

    26,365       123       1.89

%

Corporate notes

                      2,295       8       1.33

%

Residential mortgage-backed securities

    38,624       169       1.75

%

    49,917       216       1.73

%

Federal Reserve Bank stock

    1,753       26       5.98

%

    1,655       25       6.00

%

Federal Home Loan Bank stock

    3,167       64       8.10

%

    3,167       57       7.27

%

Loans (1) (2)

    603,795       6,534       4.35

%

    454,663       4,717       4.21

%

Earning assets

    700,969       6,978       4.00

%

    587,854       5,178       3.57

%

Other assets

    9,773                       7,303                  

Total assets

  $ 710,742                     $ 595,157                  

Liabilities & Equity

                                               

Interest checking (NOW)

  $ 35,248       10       0.12

%

  $ 25,798       10       0.16

%

Money market deposits and savings

    169,410       102       0.24

%

    150,034       93       0.25

%

CDs

    47,760       27       0.23

%

    40,689       7       0.06

%

Borrowings

    22,144       57       1.04

%

    17,503       48       1.12

%

Total interest bearing deposits and borrowings

    274,562       196       0.29

%

    234,024       158       0.27

%

Demand deposits

    366,468                       296,098                  

Other liabilities

    3,990                       2,901                  

Total liabilities

    645,020                       533,023                  

Equity

    65,722                       62,134                  

Total liabilities & equity

  $ 710,742                     $ 595,157                  
                                                 

Net interest income / spread

          $ 6,782       3.71

%

          $ 5,020       3.30

%

                                                 

Net interest margin

                    3.89

%

                    3.46

%


 

(1)

Before allowance for loan losses and net deferred loan fees and costs. Included in net interest income was net loan origination cost amortization of $17,000 and $6,000 for the three months ended March 31, 2016 and 2015, respectively.

 

(2)

Includes average non-accrual loans of $712,000 and $632,000 for the three months ended March 31, 2016 and 2015, respectively.

 

The Volume and Rate Variances table below sets forth the dollar difference in interest earned and paid for each major category of interest earning assets and interest bearing liabilities for the noted period, and the amount of such change attributable to changes in average balances (volume) or changes in average interest rates. Volume variances are equal to the increase or decrease in the average balance times the prior period rate and rate variances are equal to the increase or decrease in the average rate times the prior period average balance. Variances attributable to both rate and volume changes are equal to the change in rate times the change in average balance and are included below in the average volume column.

 

 

   

Three Months Ended March 31, 2016 Compared to 2015

Increase (Decrease) Due to Changes in:

 

(in thousands)

 

Volume

   

Rate

   

Total

 

Interest income:

                       

Interest earning deposits at other financial institutions

  $ (27

)

  $ 18     $ (9

)

U.S. Treasuries and Gov’t agencies

    41       (2

)

    39  

Corporate notes

    (8

)

          (8

)

Residential mortgage-backed securities

    (49

)

    2       (47

)

Federal Reserve Bank stock

    1             1  

Federal Home Loan Bank stock

          7       7  

Loans

    1,644       173       1,817  

Total increase in interest income

    1,606       194       1,800  

Interest expense:

                       

Interest checking (NOW)

    3       (3

)

     

Money market deposits and savings

    12       (3

)

    9  

CDs

    1       19       20  

Borrowings

    12       (3

)

    9  

Total increase in interest expense

    28       10       38  

Net increase in net interest income

  $ 1,578     $ 184     $ 1,762  

 

Provision for Loan Losses

 

During the three months ended March 31, 2016, we recorded a provision for loan losses of $200,000, compared to $150,000 for the same period last year. Criticized and classified loans generally consist of special mention, substandard and doubtful loans. Special mention, substandard and doubtful loans were $172,000, $758,000 and none, respectively, at March 31, 2016, compared to $180,000, $1.3 million and none, respectively, at March 31, 2015. There were no loan charge-offs or recoveries during the quarter ended March 31, 2016, compared to $16,000 of net loan recoveries during the same period last year. At both March 31, 2016 and December 31, 2015, the ALL to total loans was 1.50%. Management will continue to closely monitor the adequacy of the ALL and will make adjustments as warranted. Management believes that the ALL as of March 31, 2016 and December 31, 2015 was adequate to absorb probable and inherent risks in the loan portfolio. The provision for loan losses was recorded based on an analysis of the factors discussed in Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Allowance for Loan Losses.

 

As a percentage of our total loan portfolio, the amount of non-performing loans was 0.12% at both March 31, 2016 and December 31, 2015, respectively. As a percentage of our total assets, the amount of non-performing assets was 0.10% at both March 31, 2016 and December 31, 2015, respectively.

 

Non-Interest Income

 

Non-interest income was $198,000 for the quarter ended March 31, 2016, compared to $230,000 for the same period last year. There were no investment securities sold during the quarter ended March 31, 2016. During the quarter ended March 31, 2015, the Company sold $5.9 million of investment securities, recognizing gains of $75,000. With the exception of such gains, non-interest income primarily consists of customer related fee income.

 

Non-Interest Expense

 

Non-interest expense was $6.3 million for the quarter ended March 31, 2016, compared to $4.5 million for the same period last year. The increase in non-interest expense during the quarter ended March 31, 2016 as compared to the same period last year is primarily due to expenses of $861,000 and $268,000 incurred in connection with the proposed Merger with Midland and the registration statement on Form S-1 that was filed with the U.S. Securities and Exchange Commission on September 25, 2015, respectively.

 

Income Tax Provision

  

During the quarters ended March 31, 2016 and 2015, we recorded tax provisions of $209,000 and $246,000, respectively.

 

 

Financial Condition

 

Assets

 

Total assets at March 31, 2016 were $739.5 million, representing an increase of $7.5 million, or 1.0%, from $732.0 million at December 31, 2015. Cash and cash equivalents at March 31, 2016 were $52.4 million, representing a decrease of $2.2 million, or 4.0%, from $54.6 million at December 31, 2015. Loans increased by $10.7 million, from $598.4 million at December 31, 2015 to $609.2 million at March 31, 2016. Loan originations were $61.7 million during the quarter ended March 31, 2016, compared to $61.4 million during the same period last year. Prepayment speeds for the quarter ended March 31, 2016 were 15.9%, compared to 11.0% for the same period last year. Investment securities were $72.5 million at March 31, 2016, compared to $74.0 million at December 31, 2015, representing a decline of $1.5 million, or 2.0%. The weighted average life of our investment securities was 3.70 years and 3.85 years at March 31, 2016 and December 31, 2015, respectively.

 

Cash and Cash Equivalents

 

Cash and cash equivalents totaled $52.4 million and $54.6 million at March 31, 2016 and December 31, 2015, respectively. Cash and cash equivalents are managed based upon liquidity needs by investing excess liquidity in higher yielding assets such as loans and investment securities. See the section “Liquidity and Asset/Liability Management” below.

 

Investment Securities

 

The investment securities portfolio is generally the second largest component of the Company’s interest earning assets, and the structure and composition of this portfolio is important to any analysis of the financial condition of the Company. The investment portfolio serves the following purposes: (i) it can be readily reduced in size to provide liquidity for loan balance increases or deposit balance decreases; (ii) it provides a source of pledged assets for securing certain deposits and borrowed funds, as may be required by law or by specific agreement with a depositor or lender; (iii) it can be used as an interest rate risk management tool, since it provides a large base of assets, the maturity and interest rate characteristics of which can be changed more readily than the loan portfolio to better match changes in the deposit base and other funding sources of the Company; and (iv) it is an alternative interest earning use of funds when loan demand is weak or when deposits grow more rapidly than loans.

 

At March 31, 2016, investment securities totaled $72.5 million compared to $74.0 million at December 31, 2015. The Company’s investment portfolio is primarily composed of residential mortgage-backed securities issued by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation and debt securities issued by Government Sponsored Agencies. The underlying loans for the mortgage-backed securities are residential mortgages that were primarily originated beginning in 2005 through the current period. These loans are geographically dispersed throughout the United States. At March 31, 2016 and December 31, 2015, the weighted average yield and weighted average life of these residential mortgage-backed securities were 1.78% and 1.79%, respectively, and 3.26 years and 3.36 years, respectively. At March 31, 2016 and December 31, 2015, the weighted average rate and weighted average life of debt securities issued by Government Sponsored Agencies were 1.88% and 1.88%, respectively, and 4.18 years and 4.43 years, respectively.

 

There were no securities sold during the three months ended March 31, 2016. During the quarter ended March 31, 2015, the Company sold $5.9 million, of investment securities, recognizing gains of $75,000. These gains were recorded in non-interest income within the unaudited Consolidated Statement of Operations and Comprehensive Income. In addition, the unrealized gain on investment securities increased to $875,000 at March 31, 2016, compared to $18,000 at December 31, 2015. We will continue to evaluate the Company’s investments and liquidity needs and will adjust the amount of investment securities accordingly.

 

Loans

 

Loans, net of the ALL and deferred loan origination costs/unearned fees, increased 1.8%, or $10.5 million, from $589.5 million at December 31, 2015 to $600.0 million at March 31, 2016. As of March 31, 2016 and December 31, 2015, total loans outstanding totaled $609.2 million and $598.4 million, respectively. Loan originations were $61.7 million during the three months ended March 31, 2016, compared to $61.4 million during the same period last year. Prepayment speeds for the three months ended March 31, 2016 were 15.9%, compared to 11.0% for the same period last year.

 

As of March 31, 2016 and December 31, 2015, substantially all of the Company’s loan customers were located in Southern California.

 

 

Non-Performing Assets

 

The following table sets forth non-accrual loans and other real estate owned at March 31, 2016 and December 31, 2015:

 

(dollars in thousands)

 

March 31, 2016

   

December 31, 2015

 

Non-accrual loans:

               

Commercial

  $ 712     $ 712  

Total non-accrual loans

    712       712  

Total non-performing assets

  $ 712     $ 712  
                 

Non-performing assets to gross loans and OREO

    0.12

%

    0.12

%

Non-performing assets to total assets

    0.10

%

    0.10

%

 

Non-accrual loans totaled $712,000 at both March 31, 2016 and December 31, 2015. There were no accruing loans past due 90 days or more at March 31, 2016 and December 31, 2015. Gross interest income that would have been recorded on non-accrual loans had they been current in accordance with their original terms was $9,000 and $8,000 for the three months ended March 31, 2016 and 2015, respectively.

 

At both March 31, 2016 and December 31, 2015, non-accrual loans consisted of three commercial loans totaling $712,000.

 

At March 31, 2016 and December 31, 2015, the recorded investment in impaired loans was $758,000 and $759,000, respectively. At both March 31, 2016 and December 31, 2015, the Company had a specific allowance for loan losses of $35,000 on impaired loans of $140,000. There were $618,000 and $619,000 of impaired loans with no specific allowance for loan losses at March 31, 2016 and December 31, 2015, respectively. The average outstanding balance of impaired loans for the three months ended March 31, 2016 was $759,000, compared to $681,000 for the same period last year. At both March 31, 2016 and December 31, 2015, there were $712,000 of impaired loans on non-accrual status. During both the three months ended March 31, 2016 and 2015, interest income recognized on impaired loans subsequent to their classification as impaired was to $1,000. The Company stops accruing interest on these loans on the date they are classified as non-accrual and reverses any uncollected interest that had been previously accrued as income. The Company may begin recognizing interest income on these loans as cash interest payments are received, if collection of principal is reasonably assured.

 

Allowance for Loan Losses

 

The ALL is established through provisions for loan losses charged to operations and represents probable incurred credit losses in the Company’s loan portfolio that have been incurred as of the balance sheet date. Loan losses are charged against the ALL when management believes that principal is uncollectible. Subsequent repayments or recoveries, if any, are credited to the ALL. Management periodically assesses the adequacy of the ALL by reference to many quantitative and qualitative factors that may be weighted differently at various times depending on prevailing conditions. These factors include, among others:

 

 

the risk characteristics of various classifications of loans;

 

 

general portfolio trends relative to asset and portfolio size;

 

 

asset categories;

 

 

potential credit concentrations;

 

 

delinquency trends within the loan portfolio;

 

 

changes in the volume and severity of past due and other classified loans;

 

 

historical loss experience and risks associated with changes in economic, social and business conditions; and

 

 

the underwriting standards in effect when the loan was made.

  

 

Accordingly, the calculation of the adequacy of the ALL is not based solely on the level of non-performing assets. The quantitative factors, included above, are utilized by our management to identify two different risk groups (1) individual loans (loans with specifically identifiable risks); and (2) homogeneous loans (groups of loan with similar characteristics). We base the allocation for individual loans on the results of our impairment analysis, which is typically based on the present value of the expected future cash flows discounted at the loan’s effective interest rate or by using the loan’s most recent market value or the fair value of the collateral, if the loan is collateral dependent. Homogenous groups of loans are allocated reserves based on the loss ratio assigned to the pool based on its risk grade. The loss ratio is determined based primarily on the historical loss experience of our loan portfolio. These loss ratios are then adjusted, if determined necessary by management, based on other factors including, but not limited to, historical peer group loan loss data and the loss experience of other financial institutions. Loss ratios for all categories of loans are evaluated by management on a quarterly basis. Historical loss experience is determined based on a rolling migration analysis of each loan category within our portfolio. This migration analysis estimates loss factors based on the performance of each loan category over a four and a half year time period. These quantitative calculations are based on estimates and actual losses may vary materially and adversely from the estimates.

 

The qualitative factors, included above, are also utilized to identify other risks inherent in the portfolio and to determine whether the estimated credit losses associated with the current portfolio might differ from historical loss trends or the loss ratios discussed above. We estimate a range of exposure for each applicable qualitative factor and evaluate the current condition and trend of each factor. Because of the subjective nature of these factors, the actual losses incurred may vary materially and adversely from the estimated amounts.

 

In addition, regulatory agencies, as a part of their examination process, periodically review the Bank’s ALL, and may require the Bank to take additional provisions to increase the ALL based on their judgment about information available to them at the time of their examinations. No assurance can be given that adverse future economic conditions or other factors will not lead to increased delinquent loans, further provisions for loan losses and/or charge-offs. Alternatively, no assurance can be given that future economic conditions or other factors will not lead to a decline in delinquent loans, which could result in a reversal of provision for loan losses and/or loan recoveries. Management believes that the ALL as of March 31, 2016 and December 31, 2015 was adequate to absorb probable incurred credit losses inherent in the loan portfolio.

 

The following is a summary of the activity for the ALL for the three months ended March 31, 2016 and 2015:

 

(in thousands)

 

Commercial

   

Commercial

Real Estate

   

Residential

   

Land and Construction

   

Consumer

and Other

   

Total

 

Three Months Ended March 31, 2016:

                                               

Allowance for loan losses:

                                               

Beginning balance

  $ 1,807     $ 4,580     $ 907     $ 1,146     $ 521     $ 8,961  

Provision for loan losses

          115       (15

)

    100             200  

Charge-offs

                                   

Recoveries

                                   

Ending balance

  $ 1,807     $ 4,695     $ 892     $ 1,246     $ 521     $ 9,161  

Three Months Ended March 31, 2015:

                                               

Allowance for loan losses:

                                               

Beginning balance

  $ 1,752     $ 3,825     $ 747     $ 816     $ 459     $ 7,599  

Provision for loan losses

                10       100       40       150  

Charge-offs

                                   

Recoveries

    16                               16  

Ending balance

  $ 1,768     $ 3,825     $ 757     $ 916     $ 499     $ 7,765  

 

There were no loans acquired with deteriorated credit quality during the three months ended March 31, 2016 and 2015.

 

The ALL was $9.2 million, or 1.50% of our total loan portfolio, at March 31, 2016, compared to $9.0 million, or 1.50% of our total loan portfolio, at December 31, 2015. At both March 31, 2016 and December 31, 2015, our non-performing loans were $712,000, respectively. The ratio of our ALL to non-performing loans was 1,287.28% and 1,259.18% at March 31, 2016 and December 31, 2015, respectively. In addition, our ratio of non-performing loans to total loans was 0.12% at both March 31, 2016 and December 31, 2015, respectively. The ALL is impacted by inherent risk in the loan portfolio, including the level of our non-performing loans, as well as specific reserves and charge-off activities. The remaining portion of our ALL is allocated to our performing loans based on the quantitative and qualitative factors discussed above.

 

Deferred Tax Asset

 

At March 31, 2016 and December 31, 2015, we had a net deferred tax asset of $4.2 million and $4.6 million, respectively. Our net deferred tax asset primarily consists of deferred tax assets related to the allowance for loan losses and equity compensation.

 

 

A valuation allowance is required if it is “more likely than not” that a deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence, including historical financial performance, the forecasts of future income, existence of feasible tax planning strategies, length of statutory carryforward period, and assessments of the current and future economic and business conditions. Management evaluates the positive and negative evidence and determines the realizability of the deferred tax asset on a quarterly basis. Management may reestablish a valuation allowances in the future to the extent that it is determined that it is more likely than not that these assets will not be realized.

 

Deposits

 

The Company’s activities are largely based in the Los Angeles metropolitan area. The Company’s deposit base is also primarily generated from this area.

 

At March 31, 2016, total deposits were $655.0 million compared to $598.2 million at December 31, 2015, representing an increase of 9.5%, or $56.8 million. Total core deposits, which include non-interest bearing demand deposits, interest bearing demand deposits, and money market deposits and savings, were $607.3 million and $550.4 million at March 31, 2016 and December 31, 2015, respectively. Non-interest bearing deposits represent 58.6% of total deposits at March 31, 2016, compared to 60.6% at December 31, 2015.

 

The following table reflects a summary of deposit categories by dollar and percentage at March 31, 2016 and December 31, 2015:

 

   

March 31, 2016

   

December 31, 2015

 

(dollars in thousands)

 

Amount

   

Percent of
Total

   

Amount

   

Percent of
Total

 

Non-interest bearing demand deposits

  $ 383,486       58.6

%

  $ 362,451       60.6

%

Interest bearing checking

    36,385       5.5

%

    32,406       5.4

%

Money market deposits and savings

    187,381       28.6

%

    155,572       26.0

%

Certificates of deposit

    47,705       7.3

%

    47,748       8.0

%

Total

  $ 654,957       100.0

%

  $ 598,177       100.0

%

 

At March 31, 2016, the Company had two certificates of deposit with the State of California Treasurer’s Office for a total of $46.0 million, which represented 7.0% of total deposits. The deposits outstanding at March 31, 2016 are scheduled to mature in the second quarter of 2016. The Company intends to renew each of these deposits at maturity. However, there can be no assurance that the State of California Treasurer’s Office will continue to maintain deposit accounts with the Company. At December 31, 2015, the Company had two certificates of deposit with the State of California Treasurer’s Office for a total of $46.0 million, which represented 7.7% of total deposits. The Company was required to pledge $50.6 million of investment securities at both March 31, 2016 and December 31, 2015, in connection with these certificates of deposit. For further information on the Company’s certificates of deposit with the State of California Treasurer’s Office, see Part I, Item 1. Financial Statements - Note 7 “Deposits.”

 

The aggregate amount of certificates of deposit of $100,000 or more was $47.1 million at both March 31, 2016 and December 31, 2015.

 

Scheduled maturities of certificates of deposit in amounts of $100,000 or more at March 31, 2016, including deposit accounts with the State of California Treasurer’s Office and CDARS were as follows:

 

(in thousands)

       

Due within 3 months or less

  $ 47,013  

Due after 3 months and within 6 months

     

Due after 6 months and within 12 months

    125  

Due after 12 months

     

Total

  $ 47,138  

  

 

Liquidity and Asset/Liability Management

 

Liquidity, as it relates to banking, is the ability to meet loan commitments and to honor deposit withdrawals through either the sale or maturity of existing assets or the acquisition of additional funds through deposits or borrowing. The Company’s main sources of funds to provide liquidity are its cash and cash equivalents, paydowns and maturities of investments, loan repayments, and increases in deposits and borrowings. The Company also maintains lines of credit with the Federal Home Loan Bank (“FHLB”), and other correspondent financial institutions.

 

The liquidity ratio (the sum of cash and cash equivalents and available for sale investments, excluding amounts required to be pledged and operating requirements, divided by total assets) was 10.1% at both March 31, 2016 and December 31, 2015.

 

At March 31, 2016 and December 31, 2015, the Company had a borrowing/credit facility secured by a blanket lien on eligible loans at the FHLB of $183.0 million and $180.0 million, respectively. The Company had $15.0 million of long-term borrowings outstanding under this borrowing/credit facility with the FHLB at both March 31, 2016 and December 31, 2015. The Company had no overnight borrowings outstanding under this borrowing/credit facility at March 31, 2016. During the three months ended March 31, 2016, the Company had an average short-term borrowing balance of $4.0 million under this credit facility, incurring $6,000 in interest expense during this period. At December 31, 2015, the Company had a $50.0 million overnight borrowing outstanding under this borrowing/credit facility at an interest rate of 0.27%. The Company did not incur any material interest expense in connection with this borrowing and it was repaid in January 2016.

 

The following table summarizes the outstanding long-term borrowings under the borrowing/credit facility secured by a blanket lien on eligible loans at the FHLB at March 31, 2016 and December 31, 2015 (dollars in thousands):

 

Maturity Date

 

Interest Rate

   

March 31, 2016

   

December 31, 2015

 

May 23, 2016

    2.07 %     2,500       2,500  

December 29, 2016

    1.38 %     5,000       5,000  

December 30, 2016

    1.25 %     2,500       2,500  

May 2, 2018

    0.93 %     5,000       5,000  
   

Total

    $ 15,000     $ 15,000  


At March 31, 2016 and December 31, 2015, the Company also had $27.0 million in Federal fund lines of credit available with other correspondent banks that could be used to disburse loan commitments and to satisfy demands for deposit withdrawals. Each of these lines of credit is subject to conditions that the Company may not be able to meet at the time when additional liquidity is needed. As of both March 31, 2016 and December 31, 2015, the Company had pledged $2.3 million, of investments related to these lines of credit.

 

Management believes the level of liquid assets and available credit facilities are sufficient to meet current and anticipated funding needs. In addition, the Bank’s Asset/Liability Management Committee oversees the Company’s liquidity position by reviewing a monthly liquidity report. Management is not aware of any trends, demands, commitments, events or uncertainties that will result or are reasonably likely to result in a material change in the Company’s liquidity.

 

Capital Expenditures

 

As of March 31, 2016, the Company was not subject to any material commitments for capital expenditures.

 

Capital Resources

 

At March 31, 2016, the Company had total stockholders’ equity of $66.0 million, which included $127,000 in common stock, $75.7 million in additional paid-in capital, $1.2 million in retained earnings, $515,000 in accumulated other comprehensive income, and $11.5 million in treasury stock.

 

Capital

 

The Company and the Bank are subject to the various regulatory capital requirements administered by federal banking agencies. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Failure to meet minimum capital requirements can initiate certain mandatory – and possibly additional discretionary – actions by regulators that, if undertaken, could have a material and adverse effect on the business, results of operations and financial condition of the Company.

 

 

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total Tier 1 and common equity Tier 1 capital (as defined in the regulation) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes that as of March 31, 2016 and December 31, 2015, the Company and the Bank met all capital adequacy requirements to which they are subject.

 

At December 31, 2015, the most recent notification from the OCC categorized the Bank as “well-capitalized” under the regulatory framework for prompt corrective action. To generally be categorized as a “well-capitalized” financial institution, the Bank must maintain minimum total risk-based, Tier 1 risk-based, common equity Tier 1 capital and Tier 1 leverage ratios. There are no conditions or events since the notification that management believes have changed the Bank’s categorization.

 

The Company’s and the Bank’s capital ratios as of March 31, 2016 and December 31, 2015 are presented in the table below:

 

   

Company

   

Bank

   

For Capital Adequacy

Purposes

   

For the Bank to be “Well-

Capitalized” Under

Prompt Corrective

Measures

 

(dollars in thousands)

 

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

 

March 31, 2016:

                                                               

Total Risk-Based Capital Ratio

  $ 73,675       11.20

%

  $ 73,173       11.13

%

  $ 52,618       8.00

%

  $ 65,772       10.00

%

Tier 1 Risk-Based Capital Ratio

  $ 65,437       9.95

%

  $ 64,935       9.87

%

  $ 39,464       6.00

%

  $ 52,618       8.00

%

Common Equity Tier 1 Capital Ratio

  $ 65,437       9.95

%

  $ 64,935       9.87

%

  $ 29,598       4.50

%

  $ 42,752       6.50

%

Tier 1 Leverage Ratio

  $ 65,437       9.22

%

  $ 64,935       9.14

%

  $ 28,401       4.00

%

  $ 35,523       5.00

%

December 31, 2015:

                                                               

Total Risk-Based Capital Ratio

  $ 73,029       11.24

%

  $ 72,520       11.16

%

  $ 51,992       8.00

%

  $ 64,989       10.00

%

Tier 1 Risk-Based Capital Ratio

  $ 64,891       9.98

%

  $ 64,381       9.91

%

  $ 38,994       6.00

%

  $ 51,991       8.00

%

Common Equity Tier 1 Capital Ratio

  $ 64,891       9.98

%

  $ 64,381       9.91

%

  $ 29,245       4.50

%

  $ 42,243       6.50

%

Tier 1 Leverage Ratio

  $ 64,891       9.00

%

  $ 64,381       8.92

%

  $ 28,852       4.00

%

  $ 36,078       5.00

%

 

On July 2, 2013, the Federal Reserve approved the final rules implementing the Basel Committee on Banking Supervision's (“BCBS”) capital guidelines for U.S. banks. Under the final rules, minimum requirements will increase for both the quantity and quality of capital held by the Company. The rules include a new common equity Tier 1 capital to risk-weighted assets ratio of 4.5%. The new rules also require a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets over each of the required capital ratios that will be phased in from 2016 to 2019 and must be met to avoid limitations the ability of the Bank to pay dividends, repurchase shares or pay discretionary bonuses. During 2016, the phased-in portion of the capital conservation buffer is 0.625%. The final rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and require a minimum leverage ratio of 4.0%. The final rules also implement strict eligibility criteria for regulatory capital instruments, excluding trust preferred securities, mortgage servicing rights and certain deferred tax assets, and including unrealized gains and losses on available for sale debt and equity securities. On July 9, 2013, the FDIC and OCC also approved, as an interim final rule, the regulatory capital requirements for U.S. banks, following the actions of the FRB. The FDIC and OCC's rules are identical in substance to the final rules issued by the FRB.

 

The phase-in period for the final rules commenced for the Company and the Bank on January 1, 2015, with full compliance with all of the final rule's requirements phased in over a multi-year schedule. For capital adequacy purposes, the capital ratios of the Company and the Bank would currently be in compliance with the capital conservation buffer discussed above assuming the 2.5% capital conservation buffer was fully phased in as of March 31, 2016. Management will continue to closely monitor these ratios throughout the phase in period and beyond, and intends to take appropriate action, if necessary, to ensure that as the additional requirements are phased in that the BCBS capital guidelines are satisfied. Appropriate actions may include accessing capital markets, the disposition of assets, as well as other actions deemed necessary at that time.

 

Dividends

 

In the ordinary course of business, the Company is dependent upon dividends from the Bank to provide funds for the payment of dividends to shareholders and to provide for other cash requirements. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits for that year combined with the retained net profits for the preceding two years. Currently, the Bank is prohibited from paying dividends to the Company until such time as the accumulated deficit is eliminated.

 

To date, the Company has not paid any cash dividends. Payment of stock or cash dividends in the future will depend upon earnings and financial condition and other factors deemed relevant by the Company’s Board of Directors, as well as the Company’s legal ability to pay dividends. Accordingly, no assurance can be given that any cash dividends will be declared in the foreseeable future.

 

 

Off-Balance Sheet Arrangements

 

In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and letters of credit. To varying degrees, these instruments involve elements of credit and interest rate risk in excess of the amount recognized in the statement of financial position.

 

(in thousands)

 

March 31, 2016

   

December 31, 2015

 

Commitments to extend credit

  $ 160,674     $ 159,855  

Commitments to extend credit to directors and officers (undisbursed amount)

  $ 662     $ 380  

Standby/commercial letters of credit

  $ 3,090     $ 3,245  

Guarantees on revolving credit card limits

  $ 731     $ 671  

Outstanding credit card balances

  $ 105     $ 82  

 

The Company maintains an allowance for unfunded commitments, based on the level and quality of the Company’s undisbursed loan funds, which comprises the majority of the Company’s off-balance sheet risk. As of March 31, 2016 and December 31, 2015, the allowance for unfunded commitments was $395,000 and $345,000, respectively, which represented 0.24% and 0.21% of the undisbursed commitments and letters of credit, respectively.

 

Management is not aware of any other off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, and results of operations, liquidity, capital expenditures or capital resources that is material to investors.

 

For further information on commitments and contingencies, see Part I, Item 1. Financial Statements - Note 9 “Commitments and Contingencies.”

 

Item 3.

Quantitative and Qualitative Disclosure About Market Risk

 

Not applicable.

 

Item 4.

Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

The Company maintains disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the U.S. Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to management, including the Principal Executive Officer and the Principal Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

The Company’s management, with the participation of our Principal Executive Officer and Principal Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the U.S. Securities and Exchange Commission’s rules and forms, and is accumulated and communicated to management, including the Principal Executive Officer and the Principal Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.

  

Changes in Internal Controls

       

There have not been any changes in the Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2016, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

PART II — OTHER INFORMATION

 

Item 1.

Legal Proceedings

 

On May 3, 2016, a putative stockholder class action lawsuit, captioned Dean Drulias v. 1st Century Bancshares, Inc. et. al, Case No. 16CV294673, was filed in the Superior Court of the State of California in and for the County of Santa Clara in connection with the proposed Merger between the Company and Midland (the “Drulias Action”). The Drulias Action alleges, among other things, that the members of the Company’s board of directors breached their fiduciary duties by causing the Company to agree to the Merger based on the individual interests of such directors as opposed to the best interests of the Company’s stockholders. The Drulias Action also alleges that the Company and the Company’s board of directors failed to disclose material information in the preliminary proxy statement filed with the Securities and Exchange Commission in connection with the Merger. The plaintiff in this action seeks, among other things, declaratory and injunctive relief, compensatory and/or rescissory damages, interest, attorney’s fees, expert fees and other costs, and other relief. At this stage, it is not possible to predict the outcome of the proceedings or their impact on the Company or the Merger.

 

In the ordinary course of operations, the Company may be party to various other legal proceedings.

 

Item 1A.

Risk Factors

 

Other than the additional risk factors set forth below related to the Merger with Midland, management is not aware of any material changes to the risk factors discussed in Part 1, Item 1A of the Annual Report on Form 10-K for the year ended December 31, 2015. In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the risk factors discussed in Part I, Item 1A of the Annual Report on Form 10-K for the year ended December 31, 2015, which could materially and adversely affect the Company’s business, financial condition and results of operations. The risks described below and in the Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not presently known to management or that management currently believes to be immaterial may also materially and adversely affect the Company’s business, financial condition or results of operations.

 

The proposed Merger is subject to a number of conditions precedent, including stockholder approval, the receipt of certain regulatory approvals required from the Federal Reserve and the OCC without the imposition of a Burdensome Condition (as defined in the Merger Agreement) and certain conditions regarding the continued employment of and compliance with obligations under the employment agreements entered into with MidFirst by the Company’s Chief Executive Officer and Chief Operating Officer, that, if not satisfied or not satisfied in a timely manner, could delay or prevent the consummation of the proposed Merger.

 

Among other things, the Merger Agreement must be adopted by the affirmative vote by the holders of a majority of the outstanding shares entitled to vote on the proposal at a stockholders’ meeting duly called and held for such purpose. Although we intend to call a special meeting of stockholders to consider and vote on the adoption of the Merger Agreement, stockholders could seek to enjoin the meeting. Even if such stockholder meeting is ultimately held, there is no guarantee that our stockholders will adopt the Merger Agreement by the requisite vote at such meeting, or at all.

 

In addition, before the proposed Merger may be consummated, certain regulatory approvals required from the Federal Reserve and the OCC must be obtained and all statutory waiting periods in respect thereof must have expired without the imposition of a Burdensome Condition (as defined in the Merger Agreement). There can be no assurance that these regulatory approvals, or any other regulatory approvals that might be required to consummate the proposed Merger, will be obtained and, if obtained, there can be no assurance as to the timing of any approvals or the ability to obtain the approvals on satisfactory terms. If the proposed Merger does not receive, or timely receive, the required regulatory approvals, or if another event occurs delaying or preventing the proposed Merger, such delay or failure to complete the proposed Merger may create uncertainty or otherwise have negative consequences that may materially and adversely affect our financial condition and results of operations, as well as the price per share for our common stock.

 

In addition, the obligation of Midland to consummate the proposed Merger is further subject to the satisfaction or waiver of certain conditions regarding the continued employment of the Company’s Chief Executive Officer and Chief Operating Officer and such officers’ compliance with obligations under the employment agreements entered into with MidFirst concurrently with the execution and delivery of the Merger Agreement. If these employees cease to be employed by the Company for any reason, including for reasons that are not within our control, or if these employees fail to comply with the obligations under the employment agreements, the consummation of the proposed Merger may be prevented, materially delayed or materially impaired.

 

Under the terms of the Merger Agreement, the consummation of the Merger is also subject to other customary conditions. Satisfaction of certain of the conditions is not within our control, and difficulties in otherwise satisfying the conditions may prevent, materially delay or materially impair the consummation of the proposed Merger. It is also possible that a fact, circumstance, event, change, effect, development or occurrence since the date of the Merger Agreement may result in a Company Material Adverse Effect (as defined in the Merger Agreement) with respect to the Company, the non-occurrence of which is a condition to the consummation of the proposed Merger. We cannot predict with certainty whether and when any of the required conditions will be satisfied.

 

 

The consideration to be paid under the Merger Agreement will not be adjusted for changes in our business, assets, liabilities, prospects, outlook, financial condition or results of operations, or in the event of any change in our stock price.

 

The consideration to be paid to holders of our common stock under the Merger Agreement will not be adjusted for changes in our business, assets, liabilities, prospects, outlook, financial condition or results of operations, or changes in the market price of, analyst estimates of, or projections relating to, our common stock. For example, if we experienced an improvement in our business, assets, liabilities, prospects, outlook, financial condition or results of operations prior to the consummation of the proposed Merger, there would be no adjustment to the amount of the consideration to be paid to holders of our common stock under the Merger Agreement.

 

Termination of the Merger Agreement could negatively impact us.

 

If the proposed Merger is not consummated for any reason, we may be adversely affected and would be subject to a number of risks, including the following:

 

 

We may experience negative reactions from the financial markets, including negative impacts on our stock price;

 

 

We may experience negative reactions from our stockholders, employees, customers, lenders, suppliers, borrowers and other business partners; and

 

 

 

We may be required to pay certain fees and/or costs relating to the proposed Merger, whether or not the proposed Merger is consummated, including, in some cases, a termination fee.

 

While the proposed Merger is pending, we are subject to business uncertainties and contractual restrictions that could disrupt our business.

 

Whether or not the proposed Merger is consummated, the proposed Merger may disrupt our current plans and operations, which could have an adverse effect on our business and financial results. The pendency of the Merger may also divert management's attention and our resources from ongoing business and operations and our employees and other key personnel may have uncertainties about the effect of the pending Merger, and these uncertainties may impact our ability to retain, recruit and hire key personnel while the Merger is pending or if it fails to close. We may incur unexpected costs, charges or expenses resulting from the proposed Merger. Furthermore, we cannot predict how our customers, lenders, suppliers, borrowers and other business partners will view or react to the proposed Merger. If we are unable to reassure our customers, lenders, suppliers, borrowers and other business partners to continue transacting business with us, our financial condition and results of operations may be adversely affected.

 

The preparations for integration between Midland and the Company have occupied and we expect will occupy a significant time commitment from many of our employees and on our internal resources. If, despite our efforts, key personnel depart because of these or other reasons, our business and results of operations may be adversely affected. In addition, whether or not the proposed Merger is consummated, while it is pending we will continue to incur costs, fees, expenses and charges related to the proposed Merger, which may materially and adversely affect our financial condition and results of operations.

 

In addition, the Merger Agreement generally requires us to operate in the ordinary course of business consistent with past practice, pending consummation of the proposed Merger and also restricts us from taking certain actions with respect to our business without Midland’s consent. Such restrictions will be in place until either the proposed Merger is consummated or the Merger Agreement is terminated. These restrictions could restrict our ability to, or prevent us from, pursuing attractive business opportunities (if any) that arise prior to the consummation of the proposed Merger. For these and other reasons, the pendency of the Merger could adversely affect our business and results of operations.

 

 

In the event that the proposed Merger is not consummated, the trading price of our common stock and our future business and results of operations may be negatively affected.

 

The conditions to the consummation of the proposed Merger may not be satisfied, as described above. If the proposed Merger is not consummated, we would remain liable for significant transaction costs, and the focus of our management would have been diverted from seeking other potential strategic opportunities, in each case without realizing any benefits of the proposed Merger. For these and other reasons, not consummating the proposed Merger could adversely affect our financial condition and results of operations. Furthermore, if we do not consummate the proposed Merger, the price of our common stock may decline significantly from the current market price, which we believe reflects a market assumption that the proposed Merger will be consummated. Certain costs associated with the proposed Merger have already been incurred or may be payable even if the proposed Merger is not consummated. Further, a failed transaction may result in negative publicity and a negative impression of us in the investment community. Finally, any disruptions to our business resulting from the announcement and pendency of the proposed Merger, including any adverse changes in our relationships with our customers, lenders, suppliers, borrowers and employees or recruiting and retention efforts, could occur in the event of a failed Merger.

 

Our directors and officers have interests in the merger different from the interests of other stockholders.

 

Our executive officers and directors have interests in the proposed Merger that are different from, or in addition to, the interests of our stockholders generally. These interests include (i) the accelerated vesting and payment of Bancshares restricted shares; (ii) certain severance and other separation benefits that may be payable upon termination of employment following the consummation of the proposed Merger pursuant to new employment arrangements that certain executive officers have entered into with MidFirst in connection with the Merger; and (iii) entitlement to continued indemnification, expense advancement and insurance coverage under the Merger Agreement.

 

The Merger Agreement contains provisions that may discourage other companies from trying to acquire 1st Century.

 

The Merger Agreement contains provisions that may discourage a third party from submitting a business combination proposal to Bancshares that might result in greater value to our stockholders than the proposed Merger. These provisions include a general prohibition on soliciting, or, subject to certain exceptions, entering into discussions with any third party regarding any acquisition proposal or offers for competing transactions. In addition, upon termination of the Merger Agreement in certain circumstances, we may be required to pay Midland a termination fee of $4,500,000. Furthermore, certain directors and executive officers of Bancshares, who collectively own approximately 21.5% of the outstanding shares, have entered into a voting agreement with Midland. The voting agreement, among other things, requires such stockholders to vote all of their shares in favor of adoption of the Merger Agreement and against alternative transactions, as long as the Merger Agreement has not been terminated.

 

Stockholder litigation could prevent or delay the closing of the proposed Merger or otherwise negatively impact our business and operations.

 

We may incur additional costs in connection with the defense or settlement of the currently pending or any future stockholder litigation in connection with the proposed Merger. Such litigation may adversely affect our ability to complete the proposed Merger. Such litigation could also have an adverse effect on our financial condition and results of operations.

  

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3.

Defaults Upon Senior Securities

 

None.

 

Item 4.

Mine Safety Disclosures.

 

None.

 

Item 5.

Other Information

 

None.

 

 

Item 6.

Exhibits

 

 

2.1

Agreement and Plan of Merger, dated March 10, 2016, by and among Midland Financial Co., MC 2016 Corp., and 1st Century Bancshares, Inc. (incorporated by reference to Exhibit 2.1 to 1st Century Bancshares, Inc.’s Current Report on Form 8-K filed on March 11, 2016).*

 

 

3.1

Bylaws of 1st Century Bancshares, Inc., as amended on March 10, 2016 (incorporated by reference to Exhibit 3.1 to 1st Century Bancshares, Inc.’s Current Report on Form 8-K filed on March 11, 2016).

 

 

31.1

Principal Executive Officer Certification required under Section 302 of the Sarbanes—Oxley Act of 2002.

 

 

31.2

Principal Financial Officer Certification required under Section 302 of the Sarbanes—Oxley Act of 2002.

 

 

32

Principal Executive Officer and Principal Financial Officer Certification required under Section 906 of the Sarbanes—Oxley Act of 2002.

 

 

101.INS

XBRL Instance Document.

 

 

101.SCH

XBRL Taxonomy Extension Schema Document.

 

 

101.CAL

XBRL Taxonomy Extension Calculation Linkbase Document.

 

 

101.DEF

XBRL Taxonomy Extension Definition Linkbase Document.

 

 

101.LAB

XBRL Taxonomy Extension Label Linkbase Document.

 

 

101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document.

 

* Schedules and exhibits omitted pursuant to Item 601(b)(2) of Regulation S-K.  Bancshares agrees to furnish supplementally a copy of any omitted schedules or exhibits to the SEC upon request; provided, however, that Bancshares may request confidential treatment pursuant to Rule 24b-2 of the Exchange Act for any schedule or exhibit so furnished.

  

  

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 1ST CENTURY BANCSHARES, INC.

   
   

Date: May 5, 2016

By:

/s/ Alan I. Rothenberg.

   

Alan I. Rothenberg

   

Chairman and Chief Executive Officer

     

Date: May 5, 2016

By:

/s/ Bradley S. Satenberg.

   

Bradley S. Satenberg

   

Executive Vice President and Chief Financial Officer

 

 

46